The illusion of diversification: What’s actually included in an S&P 500 ETF?

June 16, 20225 min read
The illusion of diversification: What’s actually included in an S&P 500 ETF?
Share on facebookShare on TwitterShare on Linkedin

Key takeaways:

  • The SPDR S&P 500 ETF Trust (SPY) is a tradeable fund that tracks the popular S&P 500 index. It allows investors to easily buy into the entire inventory of the S&P 500 at a relatively accessible entry point.
  • The S&P 500 is heavily weighted toward large cap, growth-based companies, primarily from the tech sector, which challenges the idea that funds like SPY can help diversify a portfolio.
  • In a broadly diversified portfolio, the variety of asset classes is what hedges against volatility in the broader market.

Investors who believe they’re diversifying with index funds might want to think again. The SPDR S&P 500 ETF Trust (also known as SPY), which tracks the S&P 500 index, is a perfect example of a popular fund that allows for broad market exposure but offers limited diversification. By investing in SPY, investors can tap into the entire inventory of the S&P 500 index, eliminating the need to pick and choose individual stocks. But secular changes over the years have led to a concentration in the type of stocks these indexes represent. Today, the S&P 500 is heavily weighted toward large cap, growth-based companies – with technology as the leading sector–which means the S&P 500 index has become increasingly sensitive to economic volatility (i.e., rising interest rates). In a broadly diversified portfolio, the variety of asset classes is what can potentially protect against market volatility.

The S&P 500 and SPY

The S&P 500 (short for Standard & Poor’s 500) Index is one of the main equity benchmarks and it’s often used as a proxy for US equity markets . Made up of 500 large-cap U.S. stocks, the index is weighted, meaning it assigns a “weight” to each individual stock based on the market size of the corresponding entity. A designated committee maintains the 500 count, choosing and eliminating companies based on liquidity, industry and market capitalization.Exchange traded funds (ETFs) that track indices like the  S&P 500 provide a way for investors to gain exposure to the entire index at a relatively accessible entry point and at low fees.

The SPY ETF is just one example – it’s a tradeable fund that fully replicates the S&P 500 Index, holding all members of the underlying index at their target weights.

The era of tech

Buying SPY shares offers limited downside protection for investors in case there’s an economic downturn or a bearish market. Also, because of the way S&P 500 is set up, undervalued stocks can sometimes increase in weight before the index adjusts. 

Diversification, which is presented as a benefit to index investing, can also be narrower with SPY. Though the S&P 500 includes companies from different industries, which theoretically should diversify a portfolio (by industry, at least) recent trends are challenging whether it truly does.

As of June 2022, the Information Technology sector makes up over a quarter (26%) of the SPY ETF, followed by Healthcare at 14.4%. Drilling down further, the top 5 companies in the index make up over 15% of the total weight. These companies are all in Information Technology: Apple (6.4%), Microsoft (5.7%), Amazon (2.9%), Google parent company Alphabet class A and C shares (combined 3.9%), and Tesla (1.8%). 

The current composition of the index is a result of the way these businesses are valued and the way S&P chooses its stocks. In the last decade, the top 5 companies and the tech sector in general outperformed many other industries and grew their market cap levels to unprecedented highs, which translated into more weight in the index. The expectation for them is that they will keep growing, even if it’s at the expense of existing, more stable industries. This is why top performing tech sector companies have come to be known as “growth stocks.”

Growth stocks can skew the performance of the S&P 500 index toward higher risk equities. In times of market disturbance for example, these companies can be quick to react and their combined weight in the index might in turn have the power to move the S&P 500. Because it’s so strongly correlated to a single, volatile industry, the benchmark itself becomes more sensitive to volatility. In fact, amid the ongoing interest hikes now, the S&P 500 Index has declined over 20% year-to-date, with tech and growth stocks driving underperformance. 

Broader is better

Even if the S&P 500 were to reshuffle its selection of stocks to somehow exclude growth stocks, SPY can at best offer diversification by industry – a very limited scope when considering events like a war or a pandemic, which can affect all industries. 

Nobel Prize-winning American economist Harry Markowitz knew this and advocated for broad diversification instead. Portfolio optimization theory which was proposed by Markowitz in 1927 laid the foundation for modern portfolio theory (MPT), a mathematical framework for diversifying a portfolio by choosing an optimal spread of assets. It’s widely recognized today that Markowitz’s genius was in showing that diversification can reduce volatility without sacrificing return. 

MPT is integral to sophisticated investor strategies today. Akin to the idiom “the whole is greater than the sum of its parts”, it advocates for curating a portfolio that maximizes return for a given level of risk. It also centers on broad diversification and choosing asset groups with little correlation. 

Yieldstreet and diversification

Yieldstreet’s platform includes a number of products that can help weather the current market cycle, including the negative effects of higher inflation and interest rates. However, while volatile markets can be a good selling point for alternative investing, Yieldstreet is not focused on responding to the kind of cyclical swings that will always be happening. Including private market exposure in a portfolio – through a differentiated allocation to various opportunities – can help diversify and harness higher, uncorrelated returns no matter the weather.

1Source: Bloomberg

We believe our 10 alternative asset classes, track record across 470+ investments, third party reviews, and history of innovation makes Yieldstreet “The leading platform for private market investing,” as compared to other private market investment platforms.

1 Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections may not reflect actual future performance. All securities involve risk and may result in significant losses.

3 "Annual interest," "Annualized Return" or "Target Returns" represents a projected annual target rate of interest or annualized target return, and not returns or interest actually obtained by fund investors. “Term" represents the estimated term of the investment; the term of the fund is generally at the discretion of the fund’s manager, and may exceed the estimated term by a significant amount of time. Unless otherwise specified on the fund's offering page, target interest or returns are based on an analysis performed by Yieldstreet of the potential inflows and outflows related to the transactions in which the strategy or fund has engaged and/or is anticipated to engage in over the estimated term of the fund. There is no guarantee that targeted interest or returns will be realized or achieved or that an investment will be successful. Actual performance may deviate from these expectations materially, including due to market or economic factors, portfolio management decisions, modelling error, or other reasons.

4 Reflects the annualized distribution rate that is calculated by taking the most recent quarterly distribution approved by the Fund's Board of Directors and dividing it by prior quarter-end NAV and annualizing it. The Fund’s distribution may exceed its earnings. Therefore, a portion of the Fund’s distribution may be a return of the money you originally invested and represent a return of capital to you for tax purposes.

5 Represents the sum of the interest accrued in the statement period plus the interest paid in the statement period.

6 The internal rate of return ("IRR") represents an average net realized IRR with respect to all matured investments, excluding our Short Term Notes program, weighted by the investment size of each individual investment, made by private investment vehicles managed by YieldStreet Management, LLC from July 1, 2015 through and including July 18th, 2022, after deduction of management fees and all other expenses charged to investments.

7 Investors should carefully consider the investment objectives, risks, charges and expenses of the Yieldstreet Alternative Income Fund before investing. The prospectus for the Yieldstreet Alternative Income Fund contains this and other information about the Fund and can be obtained by emailing [email protected] or by referring to www.yieldstreetalternativeincomefund.com. The prospectus should be read carefully before investing in the Fund. Investments in the Fund are not bank deposits (and thus not insured by the FDIC or by any other federal governmental agency) and are not guaranteed by Yieldstreet or any other party.

8 This tool is for informational purposes only. You should not construe any information provided here as investment advice or a recommendation, endorsement or solicitation to buy any securities offered on Yieldstreet. Yieldstreet is not a fiduciary by virtue of any person's use of or access to this tool. The information provided here is of a general nature and does not address the circumstances of any particular individual or entity. You alone assume the sole responsibility of evaluating the merits and risks associated with the use of this information before making any decisions based on such information.

9 Statistics as of the most recent month end.

300 Park Avenue 15th Floor, New York, NY 10022

844-943-5378

No communication by YieldStreet Inc. or any of its affiliates (collectively, “Yieldstreet™”), through this website or any other medium, should be construed or is intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice, except for specific investment advice that may be provided by YieldStreet Management, LLC pursuant to a written advisory agreement between such entity and the recipient. Nothing on this website is intended as an offer to extend credit, an offer to purchase or sell securities or a solicitation of any securities transaction.

Any financial projections or returns shown on the website are estimated predictions of performance only, are hypothetical, are not based on actual investment results and are not guarantees of future results. Estimated projections do not represent or guarantee the actual results of any transaction, and no representation is made that any transaction will, or is likely to, achieve results or profits similar to those shown. In addition, other financial metrics and calculations shown on the website (including amounts of principal and interest repaid) have not been independently verified or audited and may differ from the actual financial metrics and calculations for any investment, which are contained in the investors’ portfolios. Any investment information contained herein has been secured from sources that Yieldstreet believes are reliable, but we make no representations or warranties as to the accuracy of such information and accept no liability therefore.

Private placement investments are NOT bank deposits (and thus NOT insured by the FDIC or by any other federal governmental agency), are NOT guaranteed by Yieldstreet or any other party, and MAY lose value. Neither the Securities and Exchange Commission nor any federal or state securities commission or regulatory authority has recommended or approved any investment or the accuracy or completeness of any of the information or materials provided by or through the website. Investors must be able to afford the loss of their entire investment.

Investments in private placements are speculative and involve a high degree of risk and those investors who cannot afford to lose their entire investment should not invest. Additionally, investors may receive illiquid and/or restricted securities that may be subject to holding period requirements and/or liquidity concerns. Investments in private placements are highly illiquid and those investors who cannot hold an investment for the long term (at least 5-7 years) should not invest.

Alternative investments should only be part of your overall investment portfolio. Further, the alternative investment portion of your portfolio should include a balanced portfolio of different alternative investments.

Articles or information from third-party media outside of this domain may discuss Yieldstreet or relate to information contained herein, but Yieldstreet does not approve and is not responsible for such content. Hyperlinks to third-party sites, or reproduction of third-party articles, do not constitute an approval or endorsement by Yieldstreet of the linked or reproduced content.

Investing in securities (the "Securities") listed on Yieldstreet™ pose risks, including but not limited to credit risk, interest rate risk, and the risk of losing some or all of the money you invest. Before investing you should: (1) conduct your own investigation and analysis; (2) carefully consider the investment and all related charges, expenses, uncertainties and risks, including all uncertainties and risks described in offering materials; and (3) consult with your own investment, tax, financial and legal advisors. Such Securities are only suitable for accredited investors who understand and are willing and able to accept the high risks associated with private investments.

Investing in private placements requires long-term commitments, the ability to afford to lose the entire investment, and low liquidity needs. This website provides preliminary and general information about the Securities and is intended for initial reference purposes only. It does not summarize or compile all the applicable information. This website does not constitute an offer to sell or buy any securities. No offer or sale of any Securities will occur without the delivery of confidential offering materials and related documents. This information contained herein is qualified by and subject to more detailed information in the applicable offering materials. Yieldstreet™ is not registered as a broker-dealer. Yieldstreet™ does not make any representation or warranty to any prospective investor regarding the legality of an investment in any Yieldstreet Securities.

YieldStreet Inc. is the direct owner of Yieldstreet Management, LLC, which is an SEC-registered investment adviser that manages the Yieldstreet funds and provides investment advice to the Yieldstreet funds, and in certain cases, to retail investors. RealCadre LLC is also indirectly owned by Yieldstreet Inc. RealCadre LLC is a broker-dealer registered with the Securities and Exchange Commission (“SEC”) and a member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Investor Protection Corporation (“SIPC”). Information on all FINRA registered broker-dealers can be found on FINRA’s BrokerCheck. Despite its affiliation with Yieldstreet Management, LLC, RealCadre LLC has no role in the investment advisory services received by YieldStreet clients or the management or distribution of the Yieldstreet funds or other securities offered on our through Yieldstreet and its personnel. RealCadre LLC does not solicit, sell, recommend, or place interests in the Yieldstreet funds.

Yieldstreet is not a bank. Certain services are offered through Synapse Financial Technologies, Inc. and its affiliates (collectively, “Synapse”) as well as certain third-party financial services partners. Synapse is not a bank and is not affiliated with Yieldstreet. Bank accounts are established by Evolve Bank & Trust. Brokerage accounts and cash management programs are provided through Synapse Brokerage LLC (“Synapse Brokerage”), an SEC-registered broker-dealer and member of FINRA and SIPC. Additional information about Synapse Brokerage can be found on FINRA’s BrokerCheck. By participating in a Synapse cash management program, you acknowledge receipt of and accept Synapse’s Terms of Service, Privacy Policy, and the applicable disclosures and agreements available in Synapse’s Disclosure Library.

Investment advisory services are only provided to clients of YieldStreet Management, LLC, an investment advisor registered with the Securities and Exchange Commission, pursuant to a written advisory agreement.

Our site uses a third party service to match browser cookies to your mailing address. We then use another company to send special offers through the mail on our behalf. Our company never receives or stores any of this information and our third parties do not provide or sell this information to any other company or service.

Read full disclosure