The equal-weighted indexing strategy is a simple alternative to market-cap weighted indices and can be a good way to gain a tactical position within a portfolio. The equal weight strategy can be used in exchange traded funds and gives each stock the same weighting within the portfolio.
“Exchange-traded funds are often used to make short term, tactical bets on certain sectors. In this case, you want exposure to an entire industry, not just to a handful of mega-cap stocks. Equal-weighted sector funds, such as Guggenheim S&P 500 Equal Weight Energy (NYSEArca: RYE) may make more sense when seeking industry exposure,” Michael Rawson wrote in a recent Morningstar article. [How Equal Weight ETFs Can Protect a Portfolio]
The equal weighting strategy gives both small and large-caps an equal-weighting within an index fund or portfolio. This allows all of the companies to be considered on an even playing field. Equal-weighted index funds tend to have higher stock turnover than market-cap weighted index funds and, as a result, they usually have higher trading costs, reports Investopedia. [ETFs and Indexing: What’s Your Style?]
An equal weighted methodology is considered an alternative form of indexing, with the basic market-cap weighted index being the most common. There are risks associated with equal weighting, such as the potential for concentration in a handful of stocks within sector funds. Additionally, equal weighted ETFs are intended for use as a tactical holding, rather than used as a core holding within a portfolio. [What is an ETF? – Part 2: Indexing]
Michael Rawson for Morningstar reports that there are three potential sources of extra return from an equal weight index. There is a small size tilt from under-weighting mega-cap stocks and over-weighting smaller stocks. Also, there is a value angle from under-weighting overpriced glamor stocks. The third potential source of return is from contrarian re-balancing. In order to maintain equal weightings, the index must sell stocks that have recently appreciated and buy stocks that have recently declined. [ETFs Drive Innovation in Index Construction]
Overall, an equal weight index is known to perform better when the market favors small or mid-cap stocks. An equal weight index also avoids excessive valuations, when the market is driven by momentum.
Equal Weight ETFs:
- Guggenheim S&P Equal Weight ETF (NYSEArca: RSP)
- Guggenheim S&P EQual Weight Technology (NYSEArca: RYT)
- First Trust NASDAQ 100 Equal Weight Index Fund (NYSEArca: QQEW)
Tisha Guerrero contributed to this article.
Read the disclaimer; Tom Lydon is a board member of the funds for Guggenheim Investments.
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.