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.