If bullish investors are right about one thing, this could be the best ETF of 2024.

As the end of the year approaches, many investors are looking to make portfolio changes. Those who can successfully predict what new investment themes will emerge next can stay ahead of the trend-following crowd. Moreover, after many investors were surprised by the strength of the 2023 rebound in major stock market benchmarks, no one wants to be caught off guard heading into 2024.

Even investors who prefer exchange-traded funds (ETFs) over individual stocks are increasingly predicting big changes in 2024. This is reflected in the massive capital inflows that one ETF is seeing. Invesco S&P 500 Equal Weight ETF (RSP 0.31%) It’s been gaining popularity lately, and many bullish investors believe this stock can outperform the market next year. However, for this ETF to beat traditional index investing, the recent trend favoring gigacap stocks would have to be reversed.

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It’s been a great year for GigaCap stock.

2023 restored investor confidence in the stock market, with high returns from market indices playing an important role. As of December 7th, S&P 500 It’s up more than 21% year to date.

But if you look a little deeper, you’ll discover some surprising trends. Nearly three-quarters of S&P 500 stocks underperformed the index. So far this year, less than 60% of the index’s constituents are up.

In fact, much of the performance of the market-cap-weighted S&P 500 has come from its largest components. The seven largest companies in the S&P 500 are all up more than 50% in 2023. Combine this incredible performance with the enormous weight these companies get when calculating index values, and it’s easy to understand how the lion’s share of the S&P’s profits are growing. By 2023, we could be influenced by these gigacap companies. In contrast, smaller companies are not performing as well, but their low weighting means their underperformance has not had a significant impact on the index as a whole.

Find (relative) value

It’s common for investors to look at what didn’t work one year to get an idea of ​​what might work the following year. As a result, many are paying attention to the smaller (but still large-cap) companies in the S&P 500, hoping they will catch up to the large-cap stocks at the top of the list.

However, if (relatively) smaller components outperform the largest components in the S&P, investors in a standard S&P 500 index ETF would not necessarily benefit much from this change. Instead, you need investments that provide higher exposure to companies that typically receive smaller weightings in market-cap-weighted ETFs.

The Invesco S&P 500 Equal Weight ETF aims to do just that. Instead of using market capitalization to weight holdings, the Invesco ETF follows a much simpler approach. Take all the stocks in the S&P 500 and invest an equal amount in each stock. Four times a year, Invesco rebalances the fund’s portfolio, taking into account price movements over the past three months and bringing all positions back into balance.

Investors have high hopes that smaller companies will do better in 2024. The $42 billion ETF has raised more than $9 billion so far in 2023. This represents just over $5 billion in inflows in 2022 and nearly $8 billion in 2021.

Risk and Reward

Of course, just because those investors put their money where their mouth is doesn’t mean they’re right. Ultimately, all new money in 2022 comes at a difficult time for equal-weight ETFs. Over the past year, the Invesco S&P 500 Equal Weight fund has lagged significantly behind the market-cap-weighted S&P fund.

RSP total return level data from YCharts.

However, over the long term, smaller companies tend to perform better than larger companies. However, these improved returns come with higher levels of volatility and risk. That means if you want to enjoy the superior risk-reward potential of equal-weight index ETFs, you’ll have to be willing to accept a few years of significant underperformance, such as 2023.