Neil Hall/Reuters
Buying an S&P 500 index fund has long been considered an easy way to gain broad market exposure and diversification.
But these days, this is increasingly not the case, warns Tony DeSpirito, BlackRock's chief investment officer for US fundamental active equity and the lead portfolio manager of the BlackRock Equity Dividend portfolios.
In the past, the largest sector in the S&P 500 has typically made up less than 20% of the index. Post-pandemic, that's changed as Big Tech companies' share prices have taken off. As the largest names in the index continue to grow in market capitalization, they've brought the index along with them and driven much of the overall market returns.
These high concentration levels leave investors vulnerable to market fluctuations and risks such as a potential resurgence in inflation, which has historically hurt growth names, according to DeSpirito.
"Most clients are probably out of balance. They've gotten growth tilted," DeSpirito told BI.
"There's an opportunity to supplement it with value," he added. DeSpirito believes it would serve investors well to take a step back from growth and increase their allocation to value stocks in 2025.
With flashy, fast-growing companies like the Magnificent Seven taking the spotlight in recent years, it's not hard to see why value has been pushed aside. Today's investors are hungry for growth stocks, which typically increase their profits at a quicker clip than value stocks, or those that trade at a lower price than intrinsic value and are priced below their peers.
But investors who aren't actively seeking growth are still overexposed to it. Even before the Magnificent Seven's run-up, the stock market had been tilting towards growth for the last decade, as low interest rates made it more attractive for investors to bet on less-established stocks, according to Björn Jesch, chief investment officer of the asset manager DWS.
These factors have created a highly concentrated market dominated by the technology sector, DeSpirito said. As a result, when investors buy the S&P 500 index, they become overexposed to growth by default.
DeSpirito sees two main reasons why investors should start shifting away from growth. Concentration risk and persistent inflation significantly shaped markets in 2024, and DeSpirito believes they'll continue to do so in 2025.
That's where value investing comes in, he said, as value stocks provide diversification on both fronts.
Market concentration is at an all-time high, surpassing dot-com bubble levels by many measures. Today, the movements of just a few stocks — for example, Nvidia — can disproportionately impact the rest of the market. Exposure to value stocks can reduce that volatility and ensure that your portfolio performance isn't at the mercy of a single stock or sector: "Value stocks look a lot different from the Magnificent Seven," DeSpirito said.
Historically, it's not been sustainable for market concentration to remain elevated for extended periods of time. Expect more stocks to contribute to the overall gains of the S&P 500 in 2025, DeSpirito predicted. Investors who diversify and add value stocks to their portfolio will benefit from the market broadening out beyond the Big Tech names.
DeSpirito added that value stocks also have an impressive track record during inflationary periods. On the other hand, high valuation multiples tend to decline in response to elevated inflation, meaning that expensively priced growth stocks are more sensitive to inflation.
Just look at 2022, when inflation surged to over 9% and central banks began to raise interest rates. The MSCI World Growth Index, which tracks large and mid-cap growth stocks, dropped almost 30% over the course of 2022, while the MSCI World Value Index only declined around 6% in the same time period.
Investors looking to get exposure to value might decide to buy a broad value index, but DeSpirito cautions against that.
The S&P 500 isn't the only index that's gotten growth-heavy: "Even when I look at value indices, they too have shifted more towards growth," DeSpirito said.
"You really need to find an active manager who stuck to their value discipline," DeSpirito added.
Investors can also take a sector approach to diversifying with value.
"Value stocks are mainly found in the financial, healthcare, industrial, and energy sectors. Growth stocks are mainly found in the technology, consumer discretionary, and communication services sectors," Jesch wrote in a recent note.
Examples of actively managed value funds include the iShares Large Cap Value Active ETF (BLCV), which DeSpirito manages, the T. Rowe Price Value ETF (TVAL), and the Avantis US Large Cap Value ETF (AVLV).
