The popularity of equal-weighted ETFs is rising, with inflows into strategies that employ an equal-weighted approach reaching net flows of $15.2bn in 2024, up 289% from $3.9bn in 2023 (source: Bloomberg; data as of 31 December 2024). However, given the extreme levels of index concentration in the US stock market, it’s crucial that investors have a full understanding of the risks that a shift from a market-cap approach to an equal-weight approach involves – particularly when active ETF options are also at their disposal.
Returns from the market-cap weight and equal-weight S&P 500 have diverged
Unlike the more traditional approach of weighting stocks in accordance with each company’s market capitalisation, equal-weighted indices assign every stock the same weight. As a result, equal-weighted ETFs award every company that they invest in the same importance, regardless of their quality, and maintain underweight positions in larger companies and overweight positions in smaller names relative to their market-cap weighted equivalents.
Nevertheless, with the market-cap and equal-weight versions of the S&P 500 holding exactly the same constituents, historically the returns from both indices have been highly correlated. More recently, however, this relationship has broken down as the performance of the market-cap weighted S&P 500 has become dominated by the small group of stocks known as the “Magnificent Seven”. This handful of stocks now represents 33% of the market-cap weighted S&P 500 (source – S&P Global, FactSet, J.P. Morgan Asset Management as of the end of December 2024), but in the equal-weighted index, where each of the 500 stocks receives only a 0.2% weight, the resulting allocation to the Magnificent Seven is just 1.4%.
The increasingly skewed risk profile of the two benchmarks is leading to much greater differentiation in returns. The sharp market rotation in July 2024, for example, helped the equal-weighted S&P 500 deliver its strongest month in three years compared to its marketcap equivalent. At the same time, the traditional return correlation between the two indices reached its lowest level on record.
A broadening of the US equity markets favours an active approach
The corporate earnings trends that have been driving the US equity market may now be finally starting to turn, with earnings dynamics increasingly pointing towards a broadening trend in earnings and performance. Full-year 2024 earnings growth figures are still likely to show significant disparity between the mega-cap stocks and the rest, but the most recent quarterly results suggest that US earnings are now gradually becoming more evenly distributed across the market.
The question for investors is how can they best position their portfolios to take advantage of these earnings trends? One way of doing so is to invest in equalweighted ETFs, which can offer diversification by reducing concentration in large-cap stocks. However, equal-weighted strategies also introduce significant active risk without considering the varying prospects of different companies.
In contrast, allocating to active ETFs, which allow portfolios to reflect strategic allocation decisions based on company fundamentals and market conditions, could lead to more optimal outcomes. Active ETFs managed by experienced active managers can provide tailored exposure to sectors and styles, and potentially generate outperformance over time, while allowing investors to better align their portfolio exposures to their risk and return objectives.
Going active in US equities with ETFs
Active alpha can play a particularly critical role in equity portfolios when the future direction of the stock market is uncertain and more differentiated stock-level performance is expected. At the current time, given the prospect of broadening returns in the US equity market, active strategies can help investors to access opportunities beyond the largest stocks.
J.P. Morgan Asset Management manages over $700 billion in US equities, offering actively managed strategies across the risk-return spectrum. Many of these active strategies are also available to UCITS ETF buyers, allowing investors to express their US equity asset allocation views across style, outcome and sustainability preferences efficiently and effectively. Our active US equity ETFs all benefit from the unique insights provided by our team of over 20 research analysts, each with more than 20 years’ average equity research experience.
Investors can approach our active US equity ETFs in three ways, depending on their individual risk and return objectives:
1. Explore an active core allocation
JPM US Research Enhanced Index Equity (ESG) UCITS ETF, which is currently the largest active UCITS ETF Source: Bloomberg, Factset and J.P. Morgan Asset Management as of 31 Dec 2024, seeks to provide clients with a core US equity exposure, with minimal sector or style deviations relative to the S&P 500 Index. At the stock-level, however, this ETF strategy takes small overweight and underweight positions – leaning into companies that are undervalued based on our fundamental research views, and underweighting or not owning companies that our analysts view as overvalued. The end result is an actively managed US equity ETF that provides risk exposures similar to a market cap-weighted benchmark, but with the potential to generate outperformance vs. the S&P 500 Index.
JPM US Equity Active UCITS ETF benefits from the same research inputs as JPM US Research Enhanced Index Equity (ESG) ETF, but has a more concentrated portfolio, holding between 80 to 100 stocks. As a result, JPM US Equity Active UCITS ETF offers higher long-term alpha potential.
2. Diversify sector and style exposure
JPM US Value Equity Active UCITS ETF provides a solution for investors looking to diversify their US equity allocation into more value-oriented companies and/ or sectors. This actively managed ETF seeks to deliver outperformance vs. the Russell 1000 Value Index – an index that invests in large cap US equities with relatively lower valuation metrics, such as price-to-book or historical sales-per-share growth – over a market cycle, through a bottom-up stock selection process that invests in both quality and contrarian value names.
The JPM US Growth Equity Active UCITS ETF, on the other hand, is benchmarked against the Russell 1000 Growth index and typically holds between 100-140 stocks, with the aim of finding underappreciated growth opportunities and US companies that possess good momentum.
3. Target different outcomes
The JPM US Equity Premium Income Active UCITS ETF and JPM Nasdaq Equity Premium Income Active UCITS ETF provide options for clients looking for a more conservative, lower beta exposure to US equity markets while also allowing regular income distribution coming from dividends and options premium.
