Last year, investors flocked to sector exchange traded funds with $35 billion flowing into such funds, bringing the total assets under management at sector ETFs to over $200 billion, according to S&P Capital IQ.
Advisors and investors also embraced smart beta ETFs, many of which are sector funds, in significant fashion. Last year, smart beta ETFs attracted $65.1 billion in new assets, nearly double the $34.2 billion hauled in by the group in 2012. [A Record Year of ETF Inflows]
One of the most established and familiar smart beta or intelligent indexing strategies is equal weight, the strategy that eschews dependence on market capitalization as a weighting tool.
“Unlike traditional sector-focused ETFs that are weighted based on the market capitalization of their constituents and can be concentrated in certain top-10 holdings (as we discuss below), equal-weight ETFs hold a roughly identical stake in all constituents and are rebalanced quarterly. To us, the benefit is that it reduces exposure to the sectors’ best performers and limits the mega-cap exposure,” said S&P Capital IQ in a new research note.
S&P Capital IQ points out that investment advisor Wilbanks, Smith & Thomas (WST) runs a sector portfolio based on the nine equal weight sector ETFs offered by Guggenheim Investments, a pioneer in the equal weight space with 14 such ETFs, including the Guggenheim S&P Equal Weight ETF (NYSEArca: RSP), which is the largest equal weight ETF.
“WST uses a proprietary, optimized momentum model and technical analysis to select securities. Assets are primarily focused on just five sector ETFs, with zero exposure to four others. The most favored sector ETF makes up nearly half of the portfolio’s assets, and four other sector ETFs make up 10% each,” according to S&P.
At the end of last year, the most favored ETF in the WST portfolio was the Guggenheim S&P Equal Weight Consumer Discretionary ETF (NYSEArca: RCD), which occupied 48% of the portfolio. Consumer discretionary was a dominant sector last year, which led to some frothy valuations. Investors have expressed some concern over those valuations and slack economic data thus far in 2014.
S&P Capital IQ rates the $151.1 million RCD marketweight. The fund is lower this year, although it slightly outpaced some of its cap-weighted rivals in 2013. The research firm also has a marketweight rating on the $397.2 million Guggenheim S&P Equal Weight Technology ETF (NYSEArca: RYT).
RYT is home to many of the tech and Internet stocks investors have come to love, including Facebook (NasdaqGM: FB), Google (NasdaqGM: GOOG) and Apple (NasdaqGM: AAPL), but those stocks do not even combine for 4.5% of the fund’s weight.
Although the equal weight strategy diminishes RYT’s leverage to large pops in a particular stock, such as the one recently seen in Google, the ETF crushed its cap-weighted rivals last year and has been less bad than those competitors this year. [Google and ETFs]
S&P Capital IQ has an overweight rating on the Guggenheim S&P Equal Weight Healthcare ETF (NYSEArca: RYH).
The $147.1 million RYH is underweight pharmaceuticals and biotech stocks compared to its cap-weighted peers, but the ETF features higher allocations to equipment, services and life sciences providers. All of those sub-sectors have helped bolster the broader health care group this year. [Health Care ETFs Still Delivering]
Tom Lydon’s clients own shares of RSP, Apple, Google and Facebook.