BlackRock Is Tweaking the S&P 500 Formula With Its New ETFs. Should You Be a Buyer?

The largest and most popular exchange-traded funds (ETFs) are those that track the performance of the S&P 500. In fact, the three largest ETFs as measured by assets under management are all ones that mimic the performance of this benchmark index. These funds include the Vanguard S&P 500 ETF (VOO -0.34%), the SPDR S&P 500 ETF Trust (SPY -0.35%), and the iShares Core S&P 500 ETF (IVV -0.34%).

However, some investors have raised concerns about the current heavy concentration of megacap stocks that now dominate the S&P 500. As of July 9, the S&P 500’s top three holdings of Nvidia, Microsoft, and Apple made up over 20% of its holdings, while its top 10 holdings represented 38% of the index. With megacap stocks dominating the S&P 500, BlackRock (BLK -0.12%) introduced a couple of new ETFs to let investors invest in the index without the megacap exposure.

In April, the company launched the iShares S&P 500 3% Capped ETF (NYSEMKT: TOPC), while earlier this month it introduced the iShares S&P 500 ex Top 100 ETF (NYSEMKT: XOEF). The former ETF tracks the performance of the S&P 500 index, but caps each holding’s weighting at a maximum of 3%. For stocks that have a weighting above 3% in the S&P 500, the excess weight is redistributed to companies that have not yet reached the 3% cap. Currently, only its top five holdings have a weighting of 3% or slightly above.

The iShares S&P 500 ex Top 100 ETF, meanwhile, tracks the S&P 500 performance excluding the 100 largest stocks, better known as the S&P 100. BlackRock promotes using the ETF in conjunction with the iShares S&P 100 ETF (OEF -0.23%), so that investors can balance their megacap exposure as they want.

Is it better to stick with an S&P 500 ETF or one of these new BlackRock ETFs?

The recent top heaviness of the S&P 500, especially among megacap technology names, has drawn a lot of attention. As such, it’s not surprising that a firm like BlackRock is looking to give investors some alternatives to keep them invested in the index, but with a little less exposure to these megacap tech stocks.

However, these funds don’t have much of a track record and come with higher expense ratios. The iShares S&P 500 ex S&P 100 ETF has an expense ratio of 0.2%, while the iShares S&P 500 3% Capped ETF is at 0.15%, although a fee waiver will bring it down to 0.09% until April 3, 2026. That compares to only 0.03% for the Vanguard 500 S&P ETF, which is the most widely held ETF.

The Vanguard 500 S&P ETF, meanwhile, also has a strong, long-term track record. The ETF has generated an average annualized return of 16.6% over the past five years and 13.6% over the past 10 years, as of the end of June.

Arguably, the S&P 500’s strong performance over the years stems directly from the index not capping the weighting of its holdings. As a market-cap-weighted index, it lets the best and strongest companies grow to become an ever-increasing percentage of the index. Ultimately, it is these mega-winners that power the market.

A J.P. Morgan study looking at stocks in the Russell 3000, which is comprised of the 3,000 largest U.S. stocks, between 1980 to 2020, found that most stocks underperformed the index, and that it was these mega-winning stocks that were responsible for most of the market’s gains. In fact, it found that two-thirds of stocks underperformed the index during this period, while 40% of stocks had negative returns.

As such, while it may sound tempting to reduce megacap exposure, I think the way the S&P has been set up is why it performs so well in the first place. A coach isn’t going to want to limit their starters’ minutes in an important game or sit them on the bench if they don’t have to, and neither should investors look to do this when it comes to investing.

As such, I’d stick to an S&P 500 ETF like the Vanguard 500 S&P ETF, and just use a consistent dollar-cost averaging strategy.