After peaks in S&P 500^® concentration, the S&P 500 Equal Weight Index has tended to outperform, suggesting that there is a relationship between changes in concentration and the relative performance of equal weighting. But, does this relationship also occur at the sector level?

Using the historical adjusted HHI (Herfindahl-Hirschman Index), we’ve previously established that concentration tends to mean-revert in most sectors. Changes in concentration affect the relative performance of the equal-weighted versions of each sector. Exhibit 1 compares the relative performance of equal-weighted sector strategies to their adjusted HHI. Equal-weighted sectors tend to outperform after peaks in their sector concentration. This is particularly noticeable for Information Technology.

The negative correlations that we consistently observe in Exhibit 1 between monthly changes in adjusted HHI and relative equal-weighted performance illustrate an important point: changes in equal-weighted relative performance and changes in concentration are not two separate things, but two aspects of the same thing. If larger stocks outperform smaller ones, concentration will increase, and equal weight will underperform. Similarly, if smaller stocks outperform, concentration will decrease, and equal weight will outperform.

Recent levels of concentration vary across sectors, as we see in Exhibit 2, which plots the historical range of the adjusted HHI for the S&P 500 and its sectors, along with a bar chart showing current levels. The range of concentration also varies widely across sectors. For example, Industrials had the widest adjusted HHI range, while Utilities had the narrowest range among sectors. We can also infer that the adjusted HHIs for Energy, Industrials and Materials have been at historically low levels, while those for Information Technology and Consumer Discretionary have been relatively high.

Sector concentration has important implications for index weighting decisions. Since Information Technology and Consumer Discretionary’s adjusted HHIs are at historically high levels, equal weighting within these sectors might be worth considering rather than cap weighting, since concentration tends to mean-revert over time. In contrast, the adjusted HHIs for Energy, Industrials, and Materials are at historically low levels. This means that cap-weighted sector strategies could be beneficial if these currently low concentration levels move upward.