Mind the (market) cap

• The U.S. equity market has shifted, with the top 20 stocks in the S&P 500 accounting for 38% of the index and 64% of its total return over the last five years, driven largely by tech giants like Microsoft, Nvidia, and Amazon.¹
• Some advisors want to increase exposure to mega cap companies due to their strong performance and fundamentals while others are looking to diversify into the next generation of market leaders.
• iShares Build ETFs enable investors to tailor portfolios to dial up their mega cap exposure with TOPT, OEF, and QTOP, bring it back to neutral with IVV, or dial it down with TOPC, QNXT, and EUSA.

The shape of the U.S. equity market has evolved dramatically over the last few years with Big Tech having a larger impact. The S&P 500, a proxy for U.S. equities, shows that the top 20 stocks now account for ~38% of the index while contributing 64% of its total return over the last five years.¹

While many headlines have called out the narrow leadership, it’s important to remember that broad market indexes simply reflect the market: each stock’s weight is proportionate to the company’s size. And as broad market cap weighted indexes represent the aggregate view of investors, they also showcase broader societal and economic shifts.

Thirty years ago, the U.S. stock market appeared more diversified across sectors (Figure 1). Once led by Consumer Staples at a 16% weight, today's market is driven more by the technology sector that is now 30% of the market.² With shifts in societal trends, traditional industries have been replaced by tech giants and service-oriented firms reflecting the evolving needs of a more connected, data-driven economy. Today, the largest companies in the index include Microsoft, Nvidia, and Amazon, which have been at the forefront of the technological innovations powering these economics shifts. These companies have delivered consistently strong earnings growth, and in return, investors have rewarded them with higher stock prices. The 20 largest companies represent ~$24tn³ in market cap- almost as large as the U.S. economy with its $29tn GDP in Q4 of 2024.⁴

Just as the world doesn’t all move to the beat of one drum, there are differing views on whether this mega cap technology leadership may continue.

On one hand, advisors who believe that this trend will persist, point to mega cap stocks being household names for a reason. According to Morningstar, 15 of the 20 stocks in the S&P 500 have a “wide” economic moat, characterized by high network effects, substantial intangible assets, cost advantages, high switching costs, or efficient scale which give them a competitive advantage.⁶ In 2024, the top 20 names have also seen revenue growth of 16.3% for the top 20 vs 5.5% for the next 480 in the index.⁷

Considering these trends and the fact that the average U.S. Asset Manager Moderate Model Allocation and average active U.S. Large Blend fund have sizeable underweights to mega cap stocks⁸, some advisors may see this as an opportunity to add more mega cap exposure to their portfolios.

On the other hand, some advisors are reassessing their allocations due to the higher risk accompanying the higher returns from the largest companies. Over the past five years, a portfolio of the top 20 names saw higher total risk than the broader S&P 500.⁹

Advisors seeking diversification from top names have several options. Equal-weighted strategies, which assign equal weight to each stock at rebalance, are common but may not reflect market consensus, treating all stocks equally regardless of their impact on the market. This approach is like giving all players equal time, without considering individual contributions to team performance.

Advisors seeking to limit exposure to top names while maintaining beta exposure may find that equal weighting strays too far from the market's risk and return. For example, using the S&P 500 as a benchmark, equally weighting stocks resulted in a 5-year tracking error of 6.7%, meaningfully higher than the at 2.0%, even though such funds typically aim to outperform the market.¹⁰

A capped approach can offer a more balanced alternative. The S&P 500 3% Capped Index, for example, caps each company at 3% during rebalances, redistributing excess weights based on market cap. Compared to equal weighting, capping can reduce tracking error and align more closely with the broader S&P 500 risk and return, while also limiting exposure to top names (figure 2).

Advisors who are rethinking their U.S. equity allocations have a broad array of tools to choose from. The iShares Build ETFs help advisors construct their portfolios with precision (Figure 2)¹²:

• The iShares Core S&P 500 ETF (IVV) provides an efficient way to access the large-cap segment of the U.S. equity market.
• Advisors who believe in the continued success of mega cap stocks may consider adding the top 20 (TOPT), top 100 stocks (OEF) in the S&P 500, or the top 30 stocks in the Nasdaq 100 (QTOP).
• Those looking to rein in exposure to these large companies may consider investing in a 3% capped version of the S&P 500 (TOPC). Alternatively, investing in the 70 smaller companies from the Nasdaq 100 (QNXT)- which includes stocks like Airbnb and Doordash – provides exposure to companies involved in the next wave of innovation and growth.
• An equal weight ETF (EUSA) can also help moderate mega cap exposure within a U.S. equity allocation as it gives companies like Target the same weight as Apple, as an example.