Long heralded as advantageous due to their ability to mitigate single-stock risk, equal-weight exchange traded funds are trailing their cap-weighted rivals this year.
In the essence of fairness, not all equal-weight ETFs are lagging their cap-weighted equivalents, but in terms of broad market funds, cap-weighted fare is standing out. Though its 1.7% year-to-date gain is far impressive, the S&P 500 is still well ahead of the Guggenheim S&P 500 Equal Weight ETF (NYSEArca: RSP), the equal-weight answer to traditional S&P 500 ETFs.
Likewise, the PowerShares QQQ (NasdaqGM: QQQ) is up 8.3% while the First Trust NASDAQ-100 Equal Weighted Index Fund (NasdaqGS: QQEW) is up just half that.
As Bloomberg reports, mega-cap companies such as Amazon (NasdaqGS: AMZN), Facebook (NasdaqGS: FB) and Google (NasdaqGS: GOOG) are surging this year. That is good news for the cap-weighted ETFs with big weights to those stocks. However, equal-weight ETFs, even sector funds, usually do not feature weights of more than 2% or 3% to individual stocks, which mutes the impact one big name can have on the fund.
Still, it can be argued 2015 is an anomaly when it comes to equal-weight ETF performance. As July 16, RSP has delivered average annualized returns of 26.1%, according to Mornigstar data. A $10,000 investment in RSP on March 10, 2009 would be worth over $43,000 today. RSP, the best ETF in the Morningstar large blend category over the aforementioned period, has generated an average annualized return of 9.4% over the past 10-years, whereas the market-cap-weighted S&P 500 Index has returned an average 8%. [Celebrating the Bull Market With ETFs]
While equal-weight ETFs have been more than legitimized over the years, some critics allege that the advantages of these products are solely tied to deeper exposure to small-caps and/or value stocks. However, three is an on an oft-overlooked driver of returns to equal-weight ETFs: Rebalancing. Efficient rebalancing of equal-weight ETFs, either sector or broad market funds, not only drives returns, but also helps these ETFs steer clear of concentration risk. [How to Evaluate ETFs]
Even with cap-weighted ETFs, the broad market ones, topping equal-weight ETFs this year, there are some equal-weight sector funds easily trumping their market-cap-weighted rivals. For example, the Guggenheim S&P Equal Weight Consumer Staples ETF (NYSEArca: RHS) and the Guggenheim S&P Equal Weight Healthcare ETF (NYSEArca: RYH) are easily topping the equivalent market cap-weighted equivalents this year.
However, cap-weighted consumer discretionary ETFs have been better thanks to large allocations to Amazon and Walt Disney (NYSE: DIS), among others.
Tom Lydon’s clients own shares of QQQ and RSP.