Beating the S&P 500: The Case for XLG, the S&P Top 50 ETF

The idea of having too much of a good thing can apply to trading and investing in ETFs as well. Case in point: the Invesco S&P 500 Top 50 ETF (XLG) is a mere $10 billion ETF, versus the $670 billion SPDR S&P 500 ETF Trust (SPY), one of a set of many huge funds (ETFs and mutual funds) that track the full S&P 500.

Yet XLG has a not-so-secret advantage that appears to be lost on traders and investors. It outperforms S&P 500 in bull markets, and doesn’t trail enough in bear markets to negate its long-term advantage.

Why Concentration Beats Diversification in Today’s Market

S&P 500 investors should take note. You’re not as diversified as you think. If 50 of the 500 stocks, the top 50 in particular, can consistently outperform the full capitalization weighted 500, why focus solely on the latter. In fact, why focus on it at all?

This is a market driven by big stocks getting bigger. Unless and until that changes in the mindset of traders (I doubt it will soon), XLG is likely to continue to perform above SPY and its peers. If that’s the case, I doubt XLG’s 0.09% expense ratio will stand in the way, versus the slightly lower rates of SPY and the rest.

Performance Through Bull and Bear Cycles

While this year’s historical anomaly, where the stock market fell 20% faster than nearly any time in recorded history, then popped right back to new highs within months, was a rare dent in XLG’s record versus SPY. It is still nicely ahead over the past 1 year, and the 5-year and 10-year margins really add up, when we consider the effect of compounding those returns.

Holdings & Valuation: More Focus, Similar P/E

How does XLG do it? By dropping the 450 smallest stocks in SPY, and putting 100% of its assets to work in the 50 biggest. When we look at them side by side, with the top 10 holdings, we see this view.

Naturally, the same 10 stocks are atop XLG and SPY, respectively. And it is also worth noting that even cutting out 90% of SPY to get to XLG’s portfolio only lifts the P/E ratio of XLG slightly (18.5x vs. 17.9x). So really, there’s not much difference here. Except better past performance for XLG.

Bottom Line: “S&P 50” as a Practical Benchmark

SPY’s top 10 holdings are around 35% of assets. That figure for XLG is closer to 60%. And with that much more focus on the ever-growing giants of the US stock market, XLG, even at $10 billion in assets, could be considered under the radar, and underrated.

So, should we start calling it the S&P 50 now? I already think of it that way, so join me if you like!