Catherine Yoshimoto
- Index methodology can significantly affect performance, particularly in concentrated sectors like U.S. tech.
- Over the past year, the Russell 1000 Technology RIC 22.5/45 Capped Index outperformed the Technology Select Sector Index by 7%.
It is a common misperception that two indexes covering the same market segment must be, essentially, interchangeable. But a better constructed US technology index can enable you to meet your investment objectives with greater precision. How an index is constructed and maintained may sound theoretical—but the potential impact on performance is real.
The concentration conundrum
The technology industry continues to be top of mind as market participants monitor the ups, downs, and changing prospects of big-name firms. As several powerhouse companies have grown into mega-cap territory, their dominance in popular indexes has come under scrutiny.
Investors are increasingly tuned in to the need to manage the concentration risk presented by traditional cap-weighted indexes. Some are seeking strategic diversification while others must also consider limits designed to ensure diversification and protect fund investors.
For example, Regulated Investment Company (RIC) capping rules for US-registered funds require that the aggregate share of companies with weights greater than 5% be limited to 50% (known as the 5/50 limit), and that no individual company have a weight greater than 25% of the fund. We go into more detail regarding FTSE Russell’s approach to capping indexes in the following blog: How and when do we cap indexes? | LSEG
Market trends—such as the dominance of mega-cap US tech stocks—shed light on the needs of clients who require capping methodologies applied to the indexes. To address these needs, we’ve launched various capped indexes that are derived from the standard (cap-weighted) indexes.
One such index is the Russell 1000 Technology RIC 22.5/45 Capped Index (RIYWC). In this index, constituents are capped quarterly so that no more than 22.5% of the index weight may be allocated to a single constituent and the sum of the weights of all constituents representing more than 4.5% of the index should not exceed 45% of the total index weight.
Capping leads to differences in holdings and performance
We see a notable difference in the largest holdings of RIYWC versus S&P’s Technology Select Sector Index, which uses a different capping methodology. The Technology Select Sector Index, Apple was weighted at less than 5% as of August 30, 2024. In RIYWC, Apple’s weight was more than 16%. Other differences in holdings—such as Alphabet and Meta Platforms—are due to underlying industry classifications (FTSE Russell uses the Industry Classification Benchmark (ICB) | LSEG, which assigns Alphabet and Meta to the ICB Technology Industry).
Index performance
Total return (%) as of August 31, 2024
Source: FTSE Russell, as of August 30, 2024. Past performance is no guarantee of future results. Please see the end for important legal disclosures. Please see the end for important legal disclosures.
Not all US technology indexes are the same—and the differences can have performance implications. As concentration remains an important theme in this market segment, your choice of index matters.
To learn more, please see our past episodes of market and index concentration from a global perspective.
Disclaimer
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