The rapid appreciation of the largest U.S. stocks has shifted the asset allocation playing field in ways that are not widely recognized. Many fewer stocks now meet the conventional definition (used by organizations such as Morningstar) of being a large company stock. As a result, most fund investors likely have far less in large capitalization stocks than they have targeted and far more in smaller companies. This can have significant costs in terms of investment underperformance and potential fiduciary liability.

How We Got Here
The 10 largest stocks in the S&P 500 have appreciated very rapidly in recent years, resulting in them representing a much higher share (39%) of the overall index than we have seen for decades.

What is not widely recognized is the impact this remarkable concentration of value has had on the asset allocation models that are widely embraced by individual and institutional investors, specifically on those using mutual funds and exchange traded funds (ETFs) as their primary investment tools.

Many investors, particularly those working with investment advisors, view their portfolios as a combination of different asset classes. At the highest level, those assets may be divided between stocks, bonds and real assets (such as real estate, commodities and infrastructure holdings). Most advisors and sophisticated investors typically break these categories into various subcategories. Bonds for example may be distinguished as short-term or long-term, government or corporate, high quality or high yield. In the U.S. equity markets, it is common to distinguish between large, mid and small capitalization stocks, and often between the growth, value and blend styles of investing. These equity sub-categories are used by Morningstar in their equity style boxes. An example is provided below for the S&P 500.

Morningstar is perhaps the most widely used source of mutual fund and ETF analytics in the U.S. Its competitors like Bloomberg, Factset, Interactive Data, Standard and Poors, and Thompson Reuters are also well-known data providers, but to a more institutional audience.

Morningstar breaks the U.S. equity market into categories based on the market capitalization (value) of the underlying companies. Large (and giant) cap companies are defined as those making up the top 70% of U.S. market capitalization, the next 20% are midcap, and the remaining 10% are small (and micro) cap.

Given the above Morningstar asset class definitions and the rapid appreciation of the largest companies, the number and size of the companies in each category is changing dramatically. As recently as 2010 (see below) almost all of the 500 companies in the S&P index may have been characterized as large cap. Today, only about 150 firms meet this definition.

Ignorance Is Not Bliss
Investors who blithely assume that the S&P 500 index is 100% large cap, or that the S&P 400 mid-cap index is 100% mid cap, are badly mistaken. Advisors that use portfolio management and reporting software that classifies fund holdings into a single asset class are effectively making this same mistake. As a result, they may be grossly overstating their client’s true allocation to large cap stocks and widely understating their exposure to smaller companies.

This mistake would have been quite costly to returns during years like 2023 and 2024 when there was a wide disparity in the performance of large and small capitalization stocks. During that period, the large company stocks of the S&P 500 index earned close to double the return of the 2000 smaller companies that make up the Russell 2000 index.

The variance of a manager’s actual portfolio mix vs. an agreed upon target could also potentially prove costly in terms of legal liability. We believe this is potentially a major problem for firms that develop target allocations for clients across multiple asset classes and implement these recommendations using mutual funds and ETFs.

The Data 
A common industry practice is to define the target size of a client’s allocation buckets, and then fill them with appropriate securities. An investor that targets U.S. equities to be allocated 70% to large cap and 30% to mid-cap might thus reasonably purchase $7,000 of the S&P 500 large cap index (SPY) and $3,000 of the S&P 400 mid-cap index (MDY).

Users of reporting and trading software (like Orion) would typically classify these as large and mid-cap funds, respectively, and indicate that this portfolio is spot on with respect to the 70/30 target. However, when looking at the underlying holdings in Morningstar (in December 2024), we find that SPY is 18% mid cap, and that MDY is over 60% small cap. Using Morningstar’s approach, the above mentioned two-holding portfolio would actually be 57% large, 24% mid, and 19% small cap (rather than 70/30/0), meaning that large and mid cap stocks are actually far below targeted levels, and small cap stocks are wildly overweighted.

This misallocation problem can be further exacerbated by security selection. Firms using DFA or similar funds (which tend to favor smaller companies) to fill their allocation buckets are likely to find themselves even further below intended large and mid-cap targets. An example is the DFA Core Equity Portfolio fund (DFEQX), which holds about $35 billion in assets. While it is a classified by Morningstar as a large-cap blend fund, it has close to 40% of its portfolio in small and mid-cap firms.

The number of companies falling into the large and mid-cap categories is changing quickly. When the biggest companies appreciate rapidly, as they have recently, fewer companies make the large cap cutoff. Based on Morningstar’s approach, there are nowhere near 500 large cap companies in the U.S. anymore--instead there are only about 150. (In December of 2024, the top 150 stocks in the S&P 500 had a combined market value equal to 70% of the value of the broad U,S, market (as measured by the Russell 3000 index). That cutoff point equates to about $67 billion in market cap. However, firms like Fidelity, still have info on their website indicating that the cutoff is $10 billion in market cap.

The Conclusion: The Goalposts Have Moved
Siblis Research data provides some historical context on how quickly things have changed. At the end of 2010, the 500 biggest stocks made up 69% of total U.S. market cap. By 6/30/24, that number was 87%. This means that the stocks outside the S&P 500 dropped in weight from 31% to 13% of the overall U.S. market in 13.5 years. The playing field hasn’t shifted modestly, it has shifted quite dramatically.

This problem extends to growth vs. value weightings as well, which are actually much more volatile than market-cap categorizations. According to data from Blackrock (which in turn relies on Morningstar) over the last 22 years, growth stocks have ranged from 23% (5/31/2002) to 46% (1/31/2024) of the Russell 3000 index. That is a lot of fluctuation for a broad-based index fund, and the pace of change can be quite rapid (at the end of 2024, the growth allocation was back down to 26.3%).

While we hope it is out there, we have not been able to find any performance reporting or trading software that generates and acts on a client's true asset mix as opposed to the mix that shows up in their reporting software. Some software allows users to spread the value of a security across multiple asset classes, which is helpful, but this is a tedious manual process that does not automatically update with changes in the underlying security’s characteristics.

The goal posts have moved. The portfolio management industry and its software providers have not caught up. Many firms may not have even caught on. This is a potentially very costly problem that no one is talking about.

Steven Ellis, CFA, is president and founder of Colorado Capital Management.