This Sector Approach is Solid Idea for Investors Seeking Portfolio Diversity

Investors fretting about the large weights of some sectors in the S&P 500 and other widely followed benchmarks can bring some diversification to their portfolio with the ALPS Equal Sector Weight (NYSEArca: EQL).

Tracking the NYSE Equal Sector Weight Index, EQL applies equal weighting to the 11 sector SPDR ETFs from State Street Global Advisors.

“EQL ensures that investors don’t miss out on a particular sector’s rally while also minimizing the exposure to any specific sector. For example, in 2015, the technology sector had the best performance of the 11 sectors, up 20.5%. A decade earlier, it was financials, which gained 21.3% in 2005,” according to InvestorPlace.

Evaluating EQL

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.

“The rationale for equal weighting the sectors has to do with the underlying problems of a capitalization-weighted index. With a cap-weighted index like the S&P 500 or the Russell 1000, the one and only thing that matters is a company’s price. There is no emphasis placed on the valuation of a company, its revenue, its profitability, or any other factor,” notes Swan Global Investments.

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 has EQL performed compared to the S&P 500? Over the past five years, it had an annualized total return of 9.27%, 213 basis points less than SPY. But it’s still getting the job done without overdoing a given segment such as technology,” reports InvestorPlace.

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.