ETFs and Indexing: Beyond Market-Cap Weighting

August 18th at 1:00am by Tom Lydon

Exchange traded funds (ETFs) come in all different shapes, sizes and indexing strategies. While weighting by company size is one of the most commonly used methods, there are other indexing strategies worth a look, too.

Quantitative Indexing. “Smart indexing” ETFs are designed to outperform the broad market. Don Dion for The Street says that one of the most important strengths of quantitative index ETFs is the dynamic aspect of their portfolios. These ETFs tend to do well in markets that are consistently moving up or down. In choppy markets, though, they’re not as easy to pin down. [The Ins and Outs of Quant ETFs.]

  • PowerShares Dynamic Large Cap Value Portfolio (NYSEArca: PWV)
  • First Trust ISE-Revere Natural Gas (NYSEArca: FCG)

Revenue Weighting. This indexing method uses company revenues to determine their weights within an index. Intuitively, weighting by revenue makes sense because bigger revenues usually mean bigger profits and better businesses. Further, market cap doesn’t always reflect a firm’s underlying business value–just look at what happened in the dot-com bubble.

  • RevenueShares Navellier Overall A-100 ETF (NYSEArca: RWV)
  • RevenueShares Small Cap ETF (NYSEArca: RWJ)

Equal Weighting. Equal weighting treats all companies equally, giving them an even share of the total weight of an ETF. Equal weighting makes sense in an environment in which large-caps and small-caps are doing well. Large-caps serve as economic bellwethers, small-caps outperform in recovery periods. But by weighting all holdings equally, a fund may miss out on true economic activity.

  • Rydex S&P Equal Weight Consumer Discretionary ETF (AMEX: RCD)
  • First Trust NASDAQ-100 Equal Weight (NYSEArca: QQEW)

Read the disclaimer; Tom Lydon is a board member of Rydex|SGI.

Tisha Guerrero contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.