The potency of equal weighting has been on display for several years in the exchange traded funds universe with equal-weight ETFs occupying a spot in the strategic beta group, one of the fastest-growing segments of the ETF industry.
As is the case with traditional ETFs, there are various ways to slice and dice equities with equal-weight ETFs. The ALPS Equal Sector Weight (NYSEArca: EQL) is an example of a unique equal-weight ETF. EQL debuted in July 2009, making it an ETF of ETFs before that concept became popular. The almost $145 million EQL applies equal weighting to the nine sector SPDR ETFs from State Street Global Advisors. [An ETF for the Indecisive Sector Investor]
“Although equal weighting of sectors can result in faster or slower earnings growth versus the S&P500 in any single year, profitability is similar on average. However equal-weighting aims to systematically avoid the excesses of the cap-weighted benchmark (such as the Financial crisis and the Tech bubble before that) making it ideal for “set-it-and-forget-it” investors who prefer somewhat less volatile returns,” said AltaVista Research in a recent research note.
AltaVista has a neutral rating on EQL, which “indicates that valuations adequately reflect the fundamentals of stocks in these funds. The majority of funds we cover fall into this category.”
Weights for EQL’s range from 10.63% for the Energy Select Sector SPDR (NYSEArca: XLE) to 11.33% for the Consumer Staples Select Sector SPDR (NYSEArca: XLP). Wide swings in sector performance can reduce diversification and increase volatility in a portfolio, according to ALPS.
Although one of the tenants equal weighting is the effort to avoid large allocations to overvalued stocks and sectors, a frequent criticism of cap-weighted ETFs, EQL’s three largest are the sector SPDR funds that track the three sectors that are currently the most richly valued relative to the S&P 500 – XLP, the Utilities Select Sector SPDR (NYSEArca: XLU) and the Consumer Discretionary Select Sector SPDR (NYSEArca: XLY). [Sector ETFs Swell in Size]