Broad market ETFs and index funds are supposed to be, well, broad, but with the likes of Amazon, Apple and Microsoft becoming larger by the day, so are their percentages in benchmarks that are supposed to be diversified, such as the S&P 500.
In other words, investors may be facing concentration risk without even knowing it. The ALPS Equal Sector Weight (NYSEArca: EQL) can help investors avoid putting too many of their eggs in one basket. Tracking the NYSE Equal Sector Weight Index, EQL applies equal weighting to the 11 sector SPDR ETFs from State Street Global Advisors.
“Of course, one can assess portfolio concentration in various ways, including by industry exposure and investment style. The amount invested in a portfolio’s largest holdings provides but one perspective. Nevertheless, it’s difficult to embrace a thesis that can’t withstand an initial, simple test,” according to Morningstar.
More Diversification, Less Concentration
Equally-weighted ETFs 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.
Data confirm EQL could be a worthwhile idea for investors looking for more diversification in their portfolios.
“Over the trailing 12 months, the percentage of assets held by the S&P 500’s 10 largest positions leapfrogged to 26%,” according to Morningstar.
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.
“Summer 2020 has established a new American record, at least during recent memory. The top positions of the S&P 500 are at their most concentrated,” according to Morningstar.
In other words, those looking for diversification benefits and to mitigate concentration may want to give EQL a look and do so soon.
Other equal-weight ETFs include the Invesco S&P 500 Equal Weight ETF (RSP), Invesco S&P 500 Equal Weight Technology ETF (NYSEArca: RYT) and the Invesco S&P Equal Weight Consumer Staples ETF (NYSEArca: RHS).
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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.
