Investors seeking to break away from a top-heavy, market-capitalization-weighted index can take a look at a new breed of smart-beta exchange traded funds that equally weight components.
For instance, the ETFS Zacks Earnings Large-Cap U.S. Index Fund (NYSEArca: ZLRG) and the ETFS Zacks Earnings Small-Cap U.S. Index Fund (NYSEArca: ZSML) not only equally weight component stocks, but the two relatively new ETFs also equally weight sectors in an attempt to help provide greater diversification and better returns. [ETF Securities Expands Equity ETF Lineup With Two More New Funds]
These funds “won’t move in lockstep with market-cap -weighted indices,” Mitchel E. Zacks, Managing Director and Portfolio Manager at Zacks Investment Management, said in a phone interview. Specifically, Zacks notes that ZLRG and ZSML both allocate the same weighting in each sector and the equal-weight methodology could drive outperformance in both of the ETFs.
In contrast, traditional market-cap-weighted indices may be top heavy and overweight stocks and sectors that have been outpeforming. During a market collapse, these same areas will likely be the hardest hit, dragging on market-cap-weighted fund.
Zacks argues that the equal-weight methodology would have outperformed, or at least mitigate the pullback, in the event of a broad decline. The strategist singles out the financials as among the largest sectors in the S&P 500 and the area exhibits some of the greatest swings during volatile conditions.