The Invesco S&P 500 Equal Weight ETF (NYSEArca: RSP), which tracks the S&P 500 Equal Weight Index, isn’t just one of the largest equal-weight ETFs. It’s one of the gold standards using this methodology due in part to some lengthy periods of outperformance relative to cap-weighted rivals.
The outperformance may be attributed to its equal-weight indexing methodology. RSP is considered one of the industry’s first and oldest smart or strategic-beta ETFs as the fund eschews traditional market-capitalization weighting schemes in favor of a very simple alternative by equally weighting each of its components, ensuring that the smaller names within the S&P 500 were weighted as heavily as their larger peers.
Of course, there are times when RSP trails the cap-weighted S&P 500, but that doesn’t mean investors should cast the equal-weight fund aside.
“Since its inception, the S&P 500® Equal Weight Index has outperformed the S&P 500 by 1.4% annually. Year-over-year performance margins, however, are anything but steady,” according to S&P Dow Jones Indices. “The S&P 500 Equal Weight Index and its cap-weight counterpart have gone through many performance cycles over the past 30 years.”
Additionally, when the equal-weight ETF rebalances each quarter, the fund reduces stock exposure to those that have outperformed, which typically grow in size, and increases positions to names that have underperformed, which have likely gotten cheaper.
Sector weights are also driven by the number of companies in each sector rather than their market value, so RSP favors consumer discretionary, real estate and utilities sectors, but the equal-weight ETF underweights areas like tech, healthcare, and financials when compared to the market cap-weighted S&P 500.
“Mega caps experienced record performance during the past year, especially in the Information Technology sector, which is up a remarkable 46% over the past 12 months (Apple, Microsoft, Alphabet, Amazon, and Facebook account for 18% of the S&P 500’s weight),” said S&P Dow Jones. “As a result, the performance of the S&P 500 Equal Weight Index, which has a small-cap bias, suffered, lagging the S&P 500 by 6.2% over the past 12 months. Exhibit 2 demonstrates that larger-cap stocks dominated within most sectors of the S&P 500, particularly in Information Technology.”
Long-term investors who are less wary of short-term twists and turns should look to an equal-weight S&P 500 ETF that focuses on smaller companies in the benchmark index as a way to generate enhanced returns over the long haul.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.