The S&P 500 is the world’s most widely followed index, and there are trillions of dollars benchmarked to its cap-weighted side. As the Invesco S&P 500 Equal Weight ETF (RSP) shows, there are other ways to tap this important equity gauge.

RSP equally weights its holdings, so the ETF leans toward smaller companies with reduced concentration risk to the largest companies when compared to the cap-weighted benchmark S&P 500 Index. The size factor offers the potential higher-than-benchmark returns associated with relatively smaller stocks within the universe being considered. Smaller capitalization companies tend to have higher growth potential, and are less widely researched.

The fund is particularly relevant at a time when a small number of companies are taking on increasingly heavy weights in the S&P 500.

“As a market capitalization-weighted index, the S&P 500 typically has a heavy concentration in a few names, and as its top five holdings  as of Dec. 14, 2020 — Microsoft (MSFT), Apple (AAPL), Amazon (AMZN), Alphabet (GOOG/GOOGL), and Facebook (FB) —have zoomed ever higher in 2020, they have come to dominate the Index’s performance,” according to Invesco research. “While the S&P 500 ostensibly measures 500 companies, the five largest companies have grown to account for nearly 22.0% of its weighting, a significant rise from 16.8% at the end of 2019.”

RSP: A Stellar Legacy and Ongoing Relevance

RSP is considered one of the industry’s first and oldest smart or strategic beta ETFs. 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 are weighted as heavily as their larger peers.

“Such a high concentration in the S&P 500’s top five holdings potentially leaves investors vulnerable in the event that the companies’ current high valuations fall back to earth. Indeed, it’s worth keeping in mind what history has taught — that companies with seemingly unassailable positions can and do fade from the scene as their business models are disrupted or they fall victim to economic forces,” notes Invesco.

RSP 1 Year Total Return

RSP also offers diversification perks investors miss out on with top-heavy cap-weighted funds and indexes.

“An equal weight approach can provide diversification benefits and reduce concentration risk by weighting each constituent company equally, so that a small group of companies does not have an outsized impact on the index,” finishes Invesco.

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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.