Mega-Cap ETFs

Companies come in all market-capitalization sizes. Large cap, mid cap, and small cap are the most common size designations, and there are many exchange-traded funds (“ETFs”) targeting these categories. However, size delineations do not stop there. Micro-cap ETFs address the lower end of the spectrum, but today we are diving into the other extreme. Mega-cap ETFs go after the largest of the large companies. There are 11 ETFs in the U.S. Mega-Cap category of the 2017 ETF Field Guide, and they are the focus of this review.

The S&P 500 Index is the most prominent benchmark for U.S. large-cap stocks. According to Morningstar, its 500 constituents have an average market capitalization of $93 billion. Many of the stocks in the S&P 500 are, in fact, mega-cap stocks, but how many of them receive that designation? Is it the 200 largest, the 30 largest, or somewhere in between? The answer is “all of the above”—it depends on who is responding to the question.

The following table of ETFs in the U.S. Mega-Cap category is sorted by the average market capitalization of their holdings. As you would expect, for ETFs using a traditional market-capitalization weighting scheme (shaded in blue), the smallest quantity of stocks produces the largest average capitalization. There are also mega-cap ETFs with alternative weighting schemes, including two equal-weighted funds (at the bottom of the list); the SPDR Dow Jones Industrial Average ETF (DIA), which uses a price-weighting scheme; and the additional filters applied to the “growth” and “value” mega-cap subsets.

U.S. Mega-Cap ETFs May 2017

The four capitalization-weighted mega-cap ETFs are listed below. All have Apple (AAPL) as their largest holding, and each fund’s allocation to Apple is included for comparison.

  • Guggenheim S&P 500 Top 50 (XLG): Launched in May 2005, this ETF formerly tracked the 50 largest stocks in the Russell universe but switched its index provider to S&P in January 2016. Russell uses a strict capitalization-weighting methodology in selecting its constituents, while a committee selects the stocks included in the S&P 500 Index. The ETF has $651 million in assets, 8.0% in AAPL, and an expense ratio of 0.20%.
  • iShares S&P 100 (OEF): Launched in October 2000, this ETF has the longest track record and highest trading activity of the four, while tracking the 100 largest stocks in the S&P 500 Index. It has $4.7 billion in assets, 6.2% in AAPL, and an expense ratio of 0.20%.
  • iShares Russell Top 200 (IWL): Launched in September 2009, this ETF tracks the 200 largest stocks in the Russell universe. It has $110 million in assets, 5.1% in AAPL, and an expense ratio of 0.15%.
  • Vanguard Mega Cap (MGC): Launched in December 2007, this ETF formerly tracked the MSCI US Large Cap 300 Index but switched to the CRSP Mega Cap Index in January 2013. The index targets the top 70% of U.S. investable market capitalization and therefore has a variable quantity of constituents. It currently has 276 stocks, $1.3 billion in assets, 4.0% in AAPL, and an expense ratio of 0.07%.

Performance of these four ETFs is nearly identical for 3-year return, 5-year return, yield, standard deviation, and drawdown. All provide acceptable exposure to the mega-cap space, and selection comes down to a matter of personal preference. If mega-cap concentration is your goal, then the Guggenheim S&P 500 Top 50 (XLG) should be your top pick. If you are more concerned about minor differences in expense ratios, then Vanguard Mega Cap (MGC) is probably the best choice. If you are an active trader, then you should opt for the added liquidity of iShares S&P 100 (OEF) and avoid the lower liquidity of the iShares Russell Top 200 (IWL).

Equal-weighting changes the complexion of ETFs built from mega-cap stocks. The average market capitalization of the Guggenheim S&P 100 Equal Weight ETF (OEW) is just 57% that of iShares S&P 100 (OEF), despite holding the same 100 stocks. When the list expands to 200 stocks, the average market capitalization of PowerShares Russell Top 200 equal Weight (EQWL) drops to just $59 billion, which is much lower than all of the other ETFs in this category and below the $93 billion of SPDR S&P 500 (SPY). Although EQWL holds only mega-cap stocks, its weighting scheme pushes it far down the capitalization scale. Depending on market behavior, this can be either beneficial or detrimental.

If you want to focus on just the growth or value subsets of mega-cap stocks, then both Vanguard and iShares provide ETFs that accomplish this task. Last but not least, no discussion of mega-cap ETFs would be complete without mentioning the SPDR Dow Jones Industrial Average ETF (DIA). While the S&P 500 might be the world’s most widely “followed” index, the Dow is the world’s most “famous” index. Composed of just 30 stocks, the Dow (and DIA), use a price-weighting scheme. While that may seem odd, it is just another way of saying it is an equal-share-quantity portfolio. This approach made it easy in the 1800s to just add the prices from a single share of every stock in the index and then divide by the number of stocks to derive the index value. A stock with a value of $100, therefore, has five times the weighting of a stock with a $20 price—not the way most people would build a portfolio today.

Disclosure: Author has no positions in any of the securities mentioned and no positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) is received from, or on behalf of, any of the companies or ETF sponsors mentioned.

Weekly Edge: Factors with Persistence of Performance

Persistence of performance, or the ability of an outperforming ETF to continue its market-beating run, is another way to describe the so-called anomaly that allows momentum strategies to work. It can be seen in stocks, sectors, country funds, and investment factors. Over the past year, it has been most evident among investment factors.

Sectors: The spread between the top-ranked and bottom-ranked Sector Benchmark ETFs widened this past week, as the recent performance dichotomy extended both the positive and negative trends. The 64-point spread has Technology providing the upside leadership, while Energy is the clear laggard. All seven sectors that were in the green a week ago posted momentum improvements today. Technology has been in the top spot for eight of the past 10 weeks, with Utilities taking the helm the other two weeks. This combination of Technology and Utilities is an odd one, as Technology is typically associated with aggressive market action, while Utilities is a defensive sector. However, you can’t argue with reality, and that is the situation the market has been faced with the past two months. A drop in crude-oil prices, trading below $48 today, has pushed the Energy sector deeper into the red and to the bottom of the relative-strength stack.

Factors: We’ve been seeing strong persistence of performance in the relative-strength rankings for the Factor Benchmark ETFs. High Beta was in the leadership role for four solid months, and now Momentum’s reign has reached the three-month mark. Growth and Low Volatility have also produced above-average results by remaining in the upper half of the rankings for a dozen weeks. However, this persistence of performance has not been a trait enjoyed by all factors. Small Size dropped from third to ninth in the first half of May, where it remains today. Value is also showing persistence but not the kind we like. Value has not been able to get any higher than two spots off the bottom for 11 straight weeks.

Global: Very little has changed in the global rankings this week. The U.S. dollar has been trending lower for the past five months, which favors traditional international ETFs that do not employ currency hedging. As a reminder, none of our Global Benchmark ETFs are currency hedged, and therefore they reflect the performance of the designated stock markets plus any gains or losses in the underlying currencies versus the U.S. dollar. Although it began the year in the leadership position, the U.S. has been relegated to the lower half of the global rankings for the better part of the year, as these currency headwinds take their toll on relative strength. The top-ranked Eurozone benchmark, iShares MSCI Eurozone (EZU), is up 18.7% year to date thanks to a 5.9% rise in the euro, which added to the 12.8% gain for stocks.

The following Edge Charts are market momentum snapshots. They provide a quick and easy way to help you visually get a handle on the overall state of the market. With these charts, you can assess both the relative strength and absolute strength (momentum) of more than 30 global equity market segments. Please refer to the Edge Chart User’s Guide for further explanation.

Weekly Edge 053117, Sector Edge, Factor Edge, Global Edge, Invest With An Edge

Disclosure: Author has no positions in any of the securities mentioned and no positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) is received from, or on behalf of, any of the companies or ETF sponsors mentioned.

“If you have an important point to make, don’t try to be subtle or clever. Use a pile driver. Hit the point once. Then come back and hit it again. Then hit it a third time—a tremendous whack.”

—Winston S. Churchill

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