Index funds that appear to track the same benchmark are producing starkly different returns this year. The divergence stems from a handful of high-flying stocks that dominate major indexes. These so-called twin funds, often expected to move in lockstep, are now acting like strangers.
The gap is most visible in funds tracking the S&P 500 and similar large-cap indexes. When a few technology giants surge, their weight in the index can skew performance. Funds with slightly different weighting rules or cash holdings respond differently to that skew. As a result, investors see returns that vary by more than a percentage point, a significant spread for passive products.
Fund providers use different methodologies to construct their portfolios. Some cap the weight of any single stock, while others let winners run untethered. That choice matters when a stock like Nvidia or Microsoft jumps sharply. A fund with a cap will sell some shares to keep balance, missing part of the rally. An uncapped fund rides the wave fully, boosting its return.
Cash levels also play a role. Funds keep small amounts of cash for redemptions and expenses. During volatile markets, that cash drags on performance when stocks climb. A fund holding 1% cash will lag a fully invested rival when the market rises. The effect compounds when the rally is narrow, driven by only a few names.
The divergence is not limited to U.S. equities. International and sector-specific funds show similar patterns. Funds tracking the same overseas index can differ based on currency hedging or regional weighting. Even funds with identical names may use different rebalancing schedules, which shifts their exposure at key moments.
For investors, the lesson is that not all index funds are identical. Reading the fine print on weighting rules and cash policies can explain unexpected performance gaps. Comparing a fund’s return to its stated benchmark is a better gauge than comparing it to a peer. Small differences in design, not market timing, often drive the long-term variance.
This year’s narrow market rally has amplified the effect. When a few stocks account for most of the index gain, fund construction details move from academic to practical. The dispersion may fade if market breadth improves, but the structural differences remain. Passive investing is not a uniform product, even when the label says otherwise.
