The S&P 500 Index (SP: .INX) contains the 500 largest listed companies in the United States. Australian investors who buy the iShares S&P 500 AUD ETF (ASX: IVV), which tracks this index, assume they are gaining a high level of diversification in a single trade.
However, the level of diversification may fall short of investors' expectations, if purchased today.
Why?
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Market capitalisation weighted
When it comes to portfolio diversification, the weighting of individual stocks matters just as much as the number of stocks.
The iShares S&P 500 AUD ETF contains 500 companies in the ETF, which may appear to be more than adequate diversification on the surface. After all, most experts recommend holding between 20-25 stocks for maximum diversification benefits. 500 holdings is certainly well above that.
However, this oversimplification ignores how they are weighted. The IVV ETF is weighted by market capitalisation. That means the largest companies are given the biggest representation.
As of June 2025, the top 10 companies make up around 40% of the S&P 500.
The top 5 holdings in June were Nvidia Inc (NASDAQ: NVDA) at 7.3%, Microsoft Corp (NASDAQ: MSFT) at 7.0% , 5.8% to Apple Inc (NASDAQ: AAPL), 3.9% to Amazon Inc (NASDAQ: AMZN), and 3.0% to Meta Platforms (NASDAQ: META).
Notably, a recent report by Goldman Sachs found that concentration had reached a level not seen since 1932. This has been driven by incredibly strong performance in large capitalisation stocks in recent years. Over the past 5 years, the S&P 500 has generated an annualised return of 16%, compared to its 30-year average of 10%. The top 10 stocks accounted for more than a third of that gain.
Sector concentration
The other important aspect to consider is the level of correlation between the top 10 companies in the S&P 500.
Correlation is a statistical measure of how two investments move together. When correlation is high, they rise and fall together.
Companies in the same sector are often highly correlated.
In the case of the S&P 500, every top 10 company except Berkshire Hathaway Inc (NYSE: BRK.A)(BRK.B) is a technology company. Therefore, any factors impacting the technology sector will have a material impact on the IVV ETF returns. This could be a range of factors including regulatory changes or technology disruption. Investors experienced this back in February with the sudden arrival of DeepSeek.
How to improve diversification?
Given these conditions, IVV ETF investors may be wondering how to improve diversification.
Investors looking to invest in an S&P 500 focused ETF today should consider the BetaShares S&P 500 Equal Weight ETF (ASX: QUS). Just like the IVV ETF, it provides exposure to the largest 500 US companies. However, each holding is equally weighted. That means, it also holds the largest technology companies, but they are weighted the same as all the other stocks in the ETF.
Should there be a material decline in the US technology sector, the QUS ETF would likely fare much better than the IVV ETF.
