Many managers struggle to outperform their benchmarks, with only 1% managing to do so over a five-year period. While index funds like the S&P 500 are popular, they are heavily influenced by a few dominant stocks, raising concerns about stretched valuations. An equal-weighted index, such as the Nasdaq Composite, may offer a solution by providing a more balanced approach.
Wall Street analysts cover about 80% of the stocks in the Nasdaq Composite, with well-known companies like Apple having over 40 analysts dedicated to analyzing their performance. Despite this extensive coverage, most investors, both retail and institutional, struggle to consistently beat the market.
The SPIVA report by Standard & Poor's reveals that the majority of active institutional investors fail to outperform benchmark indices like the S&P 500. Over the report's 23-year history, an average of 64% of active large-cap fund managers underperform the index each year, with some years showing particularly poor performance.
While some investors believe success lies in choosing the best managers, the reality is that even those who outperform one year often struggle to maintain their lead. Bond funds, in particular, have shown dismal results, with 98% of active managers trailing the general investment-grade bond benchmark.
As a result, there has been a significant shift towards index funds and exchange-traded funds (ETFs) that track various indices. The popularity of ETFs has surged, with net inflows exceeding $3 trillion from 2017 to 2022, while active mutual funds experienced net outflows.
The largest index ETFs, such as SPY, IVV, and VOO, track the S&P 500 and have attracted substantial assets. Concerns about the dominance of a few stocks in the index have led investors to consider alternatives like the equal-weight S&P 500, which offers a more balanced approach by giving each stock equal weight.
Historically, divergences in market returns tend to normalize over time, making the equal-weight index an appealing option for investors cautious about the sustainability of the current market dynamics.
