Concentration within the S&P 500^® has risen sharply in recent years, reaching multi-decade highs (see Exhibit 1) and reflecting broader trends in the U.S. large-cap equity market. As a result, more market participants are actively seeking ways to mitigate concentration risk. The S&P 500 3% Capped Index offers a practical approach by applying a straightforward capping rule: no single company may exceed a 3% weight at each quarterly rebalancing. This methodology enables market participants to measure U.S. large-cap equity performance with reduced concentration relative to the S&P 500.

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A key measure of diversification is the diversification ratio, which compares the standalone risk of individual constituents to the total risk of the combined index. A higher ratio reflects enhanced diversification. Intuitively, indices that are highly concentrated or exhibit strong constituent correlations tend to have lower diversification ratios.

Over the past five years, as the S&P 500 became increasingly concentrated, the S&P 500 3% Capped Index consistently delivered positive excess diversification (see Exhibit 2). Interestingly, between December 2022 and December 2024—despite elevated market concentration—constituent correlations within the S&P 500 declined sharply from 40% to 19%.¹ This drop in correlation contributed to an increasing diversification ratio during that period.

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Beyond diversification, the S&P 500 3% Capped Index was historically more insulated against some of the largest market declines.Exhibit 3 shows that during the S&P 500’s five worst drawdowns over the past 25 years, the S&P 500 3% Capped Index fell less in four out of five instances.

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The S&P 500 3% Capped Index’s lower weight in some of the largest names contributed to it being more insulated during periods of market stress. During peak-to-trough periods, the largest companies typically experienced the sharpest declines (see Exhibit 4). For example, in the second-largest drawdown, the average total return from capped companies was -49.0%, more than 2.5 times that of the remaining companies (-18.5%). The S&P 500 3% Capped Index, with lower weight in these names, was less affected.

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Lastly, while both indices experienced similar periods of stress, the smaller drawdowns helped the S&P 500 3% Capped Index to recover more quickly than the S&P 500 (see Exhibit 5).

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Conclusion

The S&P 500 3% Capped Index follows a transparent, rules-based methodology and seeks to address concentration concerns. By capping individual company index weights, it has historically helped to mitigate the specific risks associated with dominant names and enhance diversification. A lower weight in some of the largest names contributed to the S&P 500 3% Capped Index’s smaller drawdowns during periods of market stress.

¹ For more information, see Index Dashboard: Dispersion, Volatility & Correlation.

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