Equally-weighted exchange traded funds are the least complex and the oldest of the non-cap weighted ETF group. Investors have poured billions of dollars into various equal-weight ETFs over the years, but there can be more to equal-weight ETFs than merely assigning the same allocation to each of the fund’s holdings.
The PowerShares Russell 1000 Equal Weight Portfolio (NYSEArca: EQAL), which is less than a month old, offers investors an evolved approach to the prosaic equal-weight ETFs that currently populate the market. EQAL tracks the Russell 1000 Equal Weight Index, which applies an equal weight to nine sectors and then assigns an equal weight to each security from those sectors, according to PowerShares.
As Russell Investments notes, the traditional equal-weight methodology, like cap-weighting has flaws and biases of its own.
“This simple approach can result in notable sector biases, since the weight of each sector is determined solely by the number of companies in the sector. For example, with a simple equal-weighted-constituent methodology, if the Technology sector has 100 stocks and the Health Care sector has 50, Technology’s weight would be twice that of Health Care, regardless of the relative size of the companies within each of the two sectors,” according to Russell.
By addressing sector weights first, EQAL and its Russell index mitigate the flaws found in other equal-weight funds. [Getting Strategic With Equal-Weight ETFs]
EQAL, which charges 0.2% per year, has sector weights ranging from 2.3% for telecom up to 13% for technology. Six other sectors – industrials, health care, consumer staples, consumer discretionary, financial services and energy – receive double-digit allocations in the new ETF.
Russell’s pre-screening methodology, which includes a mandate that the share portion of a potential constituent in a notional $5 billion portfolio cannot exceed 5% of the company’s float, ensures liquidity and that the benchmark remains investable. [Looking at Alternatively-Weighted ETFs]
EQAL’s top four sector weights combine for about 48% of the new ETF’s weight. By comparison, the iShares Russell 1000 ETF (NYSEArca: IWB), the cap-weighted ETF that tracks the Russell 1000, allocates a combined 50.6% to its top three sector weights.
“Equal-weighted indexes, first introduced more than a decade ago, may be one of the earliest examples of a ‘smart beta index.’ Their straightforward methodology has at times resulted in performance superior to that of their market-cap-weighted counterparts, albeit with an uptick in volatility,” adds Russell.