The S&P 500 index is widely regarded as the benchmark for the US stock market. However, many investors may not realize how much the index is influenced by the technology sector. According to a recent analysis, the true tech weighting of the S&P 500 is over 40%, making it difficult for other sectors and active managers to outperform the index.

What is the true tech weighting of the S&P 500?

The official sector classification of the S&P 500 shows that the technology sector accounts for about 28% of the index as of February 2024. However, this does not capture the full extent of the tech exposure in the index, as many tech-related companies are classified under other sectors, such as communication services, consumer discretionary, and health care.

For example, some of the largest companies in the S&P 500, such as Amazon, Alphabet, Facebook, Netflix, and Tesla, are not considered pure tech companies, even though they derive most of their revenues and profits from technology-based products and services. Similarly, some healthcare companies, such as UnitedHealth and CVS Health, have significant tech components in their businesses, such as data analytics and digital platforms.

To estimate the true tech weighting of the S&P 500, one can use a more granular classification of the industry groups within each sector, based on the Global Industry Classification Standard (GICS). According to this approach, the tech weighting of the S&P 500 is over 40%, as shown in the table below.

As the table shows, the tech-related weight of the S&P 500 is 50.5%, which is significantly higher than the official weight of 28%. This means that more than half of the index is driven by the performance of the tech sector and its related industries.

Why does tech dominance make the S&P 500 hard to beat?

The tech dominance of the S&P 500 has several implications for investors and fund managers. One of them is that the index is hard to beat, especially for active managers who try to outperform the market by picking stocks or sectors that they believe will do better than the average.

The reason is that the tech sector and its related industries have been the main drivers of the S&P 500’s returns in the past decade, as they have benefited from the rapid growth of innovation, digitalization, and e-commerce. The tech sector alone has contributed about 40% of the total return of the S&P 500 since 2010, while the other sectors have contributed less than 10% each.

This means that to beat the S&P 500, active managers have to either overweight the tech sector and its related industries, or find other sectors or stocks that can generate higher returns than the tech sector. However, both strategies are challenging, as the tech sector is already highly valued and competitive, and the other sectors face various headwinds and uncertainties, such as the COVID-19 pandemic, the trade war, climate change, and regulatory pressures.

Another implication of the tech dominance of the S&P 500 is that the index is more volatile and concentrated than it appears. The tech sector and its related industries tend to have higher volatility and correlation than the other sectors, as they are more sensitive to changes in market sentiment, consumer preferences, and technological trends. This means that the S&P 500 is more exposed to the swings and shocks of the tech sector and its related industries, which can amplify the index’s gains or losses.

Moreover, the tech dominance of the S&P 500 has resulted in a high concentration of the index’s top holdings. As of February 2024, the top five companies in the S&P 500 are Apple, Microsoft, Amazon, Alphabet, and Facebook, which together account for about 24% of the index. This is the highest concentration of the index’s top five holdings since at least 1990, and it reflects the market dominance and the competitive advantage of these tech giants.

However, this also means that the S&P 500 is more dependent on the performance of these few companies, which can create risks and challenges for the index. For instance, if any of these companies face a major setback, such as regulatory scrutiny, a legal dispute, a cyberattack, or a loss of market share, it can have a significant impact on the index’s return. Conversely, if any of these companies achieve a breakthrough, such as a new product, a new market, or a new acquisition, it can have a significant impact on the index’s return.

What are the alternatives to the S&P 500?

Given the tech dominance of the S&P 500, some investors and fund managers may look for alternatives to the index, either to diversify their portfolios or to seek higher returns or lower risks. There are several options available, such as:

• The S&P 500 Equal Weight Index, which weights the S&P 500 companies equally rather than by market value. This reduces the concentration and the tech exposure of the index and increases the exposure to other sectors, such as financials, industrials, and consumer staples. However, this also increases the volatility and the turnover of the index, as the equal-weighted index has to rebalance more frequently to maintain equal weights.
• The S&P 500 Ex-Technology Index, which excludes the technology sector and its related industries from the S&P 500. This eliminates the tech exposure of the index and increases the exposure to the other sectors, such as health care, consumer discretionary, and communication services. However, this also reduces the growth potential and the innovation factor of the index, as the tech sector and its related industries have been the main sources of growth and innovation in the past decade.
• The S&P 500 Value Index selects the S&P 500 companies that have lower valuations and higher dividends than the average. This reduces the tech exposure of the index and increases the exposure to other sectors, such as financials, energy, and utilities. However, this also reduces the quality and momentum of the index, as the value stocks tend to have lower profitability and lower growth than the average.

In conclusion, the S&P 500 index is heavily influenced by the technology sector and its related industries, which makes the index hard to beat but also more volatile and concentrated. Investors and fund managers who want to diversify their portfolios or seek higher returns or lower risks may consider alternatives to the index, such as the equal-weighted, the ex-technology, or the value versions of the S&P 500. However, they should also be aware of the trade-offs and the challenges of these alternatives, as they may have different risk-return profiles and performance drivers than the original S&P 500.