By Spencer Jakab

How magnificent have the Mag-7 stocks been? Enough to blow up a long-term winning trade embraced by many retail investors.

Owning a portfolio of stocks like the S&P 500 via an index fund has beaten the vast majority of professionals over the decades. Fewer than 10% of mutual-fund managers have outperformed the passive approach. But owning the very same stocks in different proportions has beaten the pants off of typical index funds, even when some additional expenses are added.

Academics have long observed that, as good as they have been, capitalization-weighted indexes result in more money being plowed into big winners like Nvidia or Vistra and less into recent losers such as Intel or Walgreens Boots Alliance.

Sometimes that is justified, but stars have a tendency to overshoot and losers to redeem themselves. That reversion to the mean is one of the most reliable forces in finance. Enter the equal-weighted index fund.

For example, an exchange-traded fund begun in the spring of 2003, the Invesco S&P 500 Equal Weight ETF, has regularly rebalanced its portfolio so every stock represents about a fifth of a percent of its holdings. From its inception through the end of 2022 it gained 453%, or a whopping 134 percentage points more than the traditional index.

The wheels fell off of the strategy in 2023, though, when the ETF rose by 11.8% compared with a nearly 25% gain for the S&P 500 before dividends. The gap was even larger last year-despite expectations of a "broadening" that would see laggards catch up to the red-hot index.

Could this be the year? If so then, with valuations near historic highs, it might look more like a consolation prize-because it might be achieved by high-flying stocks like Nvidia and Palantir falling earthward, rather than through unloved stocks suddenly shining.

In 2022, for example, the equal-weight ETF beat the market by 6 percentage points by merely falling less. That isn't surprising, since the air tends to come out of highfliers during less-exuberant times.

Broadening has been touted by some investment pros as a way for the good times for markets to keep rolling despite lofty valuations. That might not be how the trend plays out. When it comes to long-term compound returns, though, solid defense beats a flashy offense.

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(END) Dow Jones Newswires

January 03, 2025 11:30 ET (16:30 GMT)

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