Long-term investors can pair smart beta ETFs to better capture returns over different points in the market cycle.
Many advisors use the Invesco S&P 500® Equal Weight ETF (RSP) as a core equity holding in a portfolio. RSP mitigates concentration risk and has provided the potential for higher returns in a cost-effective and tax-efficient way. Pairing RSP with the Invesco S&P 500 Momentum ETF (SPMO) can help access greater returns during the full market cycle.
Nick Kalivas, head of factor and core equity product strategy for Invesco, told VettaFi that RSP is naturally anti-momentum. Due to its equal weight strategy, the fund tilts toward value. At each quarterly rebalance, RSP gives every security an equal weight, effectively trimming exposure to the stocks that have outperformed and adding exposure to the stocks that have lagged.
See more: “Invesco’s Nick Kalivas on the Early Days of RSP and Smart Beta“
Conversely, momentum does the exact opposite — it latches on to what is doing well. SPMO’s underlying index comprises the stocks in the S&P 500 that have the highest momentum scores.
How Momentum Complements Equal Weight
“So if you pair [RSP] with momentum, what you’re essentially doing now is combining value and momentum together,” Kalivas said. “You’re able to pick up those companies that are really strong and showing a lot of momentum with those that maybe had lagged a little bit.”
See more: “How Equal Weighting at the Stock Level Impacts Sector Exposures”
SPMO and RSP tend to work at different times, which enhances diversification and helps generate excess returns over the full market cycle. Historically, the excess return correlation between momentum and value has tended to be negative, according to Kalivas.
“It’s the fact that now you own two strategies that are very different, but over time have proven the ability to generate excess returns,” Kalivas said. “So you get the diversification of the two and then over the cycle, kind of extract the premium that is present.”
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