ITOT: Not As Diversified As I Expected

Summary

• iShares Core S&P Total U.S. Stock Market ETF provides exposure to 2522 stocks.
• However, ITOT is not as diversified as expected, and differs from the S&P 500 only slightly.
• ITOT may outperform, but its similarity to SPY means it won't outperform by much.

The 2024 bull market has been fueled by a number of healthy sector rotations. Over the past month, it may surprise you to find Materials (XLB) are the best performing sector and have outperformed Technology (XLK) by 2.27%. This week Financials (XLF) and Industrials (XLI) are outperforming. It's not all about the "Mag 7."

Obviously, trading all these rotations would be ideal, but is nearly impossible in practice and carries a very big risk - under-exposure to the best performing sectors. An alternative is to own everything and buy an ETF like the iShares Core S&P Total U.S. Stock Market ETF (NYSEARCA:ITOT) which provides exposure to 2522 stocks from small caps to large caps and everything in-between. This article explores whether owing ITOT is a shortcut to good performance.

ITOT Overview

ITOT is an ETF in Blackrock's Core range. This means it is low cost, with an expense ratio of just 0.03%, and tax efficient as it has not distributed any capital gains. It has $54B AUM and very good liquidity with $146.52M Average Daily Dollar Volume. All its metrics are graded "A" on Seeking Alpha which I don't see very often.

ITOT is a passively managed fund which according to the Prospectus,

...seeks to track the investment results of the S&P Total Market Index™(TMI) (the “Underlying Index”), which is comprised of the common equities included in the S&P 500 ® and the S&P Completion Index™. The Underlying Index consists of all U.S. common equities listed on the New York Stock Exchange (“NYSE”) ...The securities in the Underlying Index are weighted based on the float-adjusted market value of their outstanding shares.

With 2522 stocks in its portfolio, it is very well diversified but still has a heavy weighting towards technology as the Fund Page shows.

ITOT's top 10 holdings are very similar to SPY's, as are the weightings. In fact, nearly a third of the portfolio is the same, which is why the performances of the two funds are also similar.

Obviously, the differences are in the lower weightings as ITOT holds over 2000 more stocks, more than SPY does. However, the fund holds only $6.2B, or 11.4%, in the remaining stocks outside the top 500 holdings. ITOT is primarily a large cap fund as this graphic shows.

ITOT is therefore not as diversified as I expected, although this is just a function of the portfolio composition and weightings based on float-adjusted market capitalization. It means any significant rotations from large caps to small caps won't have a significant effect on ITOT's performance.

ITOT Performance

The "Mag 7" and a handful of mega cap stocks have driven a lot of the recent bull market. For this reason, ITOT has lagged QQQ and SPY since the October '22 bottom, although it is not far behind SPY for obvious reasons highlighted in the previous section.

In the shorter-term, since the October '23 bottom, the divergences have narrowed and ITOT has outperformed SPY.

The situation switches again over the last 3 months as SPY leads, ITOT is second and QQQ is lagging.

The recent rotation out of technology and the "Mag 7" has always been a risk as valuations have become more and more stretched, but obviously no-one really wants to be out of this hot sector completely. ITOT is therefore a decent alternative as it is weighted heavily towards technology and large cap stocks, but with some exposure to small caps. This exposure is too small to suggest ITOT can outperform significantly should small caps outperform, but this obviously works both ways - in the last 18 months small caps have underperformed and this hasn't weighed too much on ITOT and has allowed it to just about keep pace with SPY.

Should the rotations of 2024 continue, ITOT could perform well and even outperform QQQ and SPY if small caps rally significantly. However, any differences are likely to be quite small.

Risks

The risks involved with holding ITOT are very similar to the risks involved with holding SPY. There is an additional risk from a "higher for longer" rate stance by the Fed as most small cap stocks are reliant on borrowing. A sharp market turndown could effect ITOT more than SPY due to higher volatility in small caps.

Another risk comes from underperforming a sector rotation strategy. If you have strong conviction that there will be a rotation out of mega cap technology stocks into small caps, then holding ITOT is not the best way to implement it. This is more a risk v reward issue, though. If you are wrong about the rotation, ITOT will help mitigate the underperformance. If you are correct about the rotation, you may kick yourself as ITOT will only outperform very slightly.

Conclusions

ITOT is a way to diversify across 2522 stocks and never be out of any sector. That said, it is not as diversified as you may think as the smallest 2022 stocks compose only 11.4% of the portfolio.

Due to its composition, ITOT may never outperform SPY significantly, but neither should it underperform by a large margin. On the plus side, it could outperform individual sectors and takes the risk (and much of the potential reward) out of a sector rotation strategy.