Some characteristics of equal-weight exchange traded funds, such as the Invesco S&P 500 Equal Weight ETF (RSP), are frequently repeated.
Those include the fact that these funds significantly reduce concentration risk relative to their cap-weighted rivals and the fact that the value factor is often a primary driver of out-performance generated by equal-weight strategies. While the latter is often levied in the form of criticism, investors shouldn’t get wrapped up in that.
In fact, the current environment is rather conducive to considering an equal-weight fund such as RSP because the concentration in the cap-weighted S&P 500 is running high, as are the benchmark’s multiples.
“The extreme concentration in the cap-weighted S&P 500, valuation stretch in the cap-weighted S&P 500, and a rebirth of the reopening trade are potential positives for RSP,” according to Invesco research. “The S&P 500 was historically concentrated at the end of Q3 with the ten largest companies accounting for 29.3% of the Index, and $11.4 trillion in market cap. The concentration in the cap-weighted S&P 500 reduces its effectiveness in providing core equity exposure. Through its equally-weighted methodology, RSP is overweight 394 companies compared to the cap-weighted S&P 500.”
Elimination of concentration risk is an obvious benefit of a fund like RSP, but equal-weight’s value proposition is material as well, and it’s on full display these days.
“Not only is the cap-weighted S&P 500 concentrated, it is also expensively valued relative to RSP. At the end of Q3, RSP’s one year forward price-to-earnings (PE) ratio was 17.53 and 5% above the 10-year median. In contrast, the S&P 500’s one year forward PE ratio was 21.03 and 22% above the 10-year median,” adds Invesco.
What’s interesting about RSP’s value advantage is that the ETF isn’t a dedicated value fund; its 37% allocation to value stocks isn’t excessive, and the fund isn’t bereft of growth and blend stocks. Moreover, RSP has appeal into year-end, and to start the new year, macro conditions, despite supply chain woes, could prove supportive of the equal-weight strategy.
“Rising vaccine rates and new COVID treatment may help to normalize economic activity to the potential benefit of smaller companies by helping broaden economic growth. Although the economy faces the headwind of bottlenecks and supply chain disruptions, leading indicators of economic activity remain favorable for potential profit growth,” concludes Invesco.
RSP is up 31.47% over the past 12 months, an advantage of 41 basis points over the cap-weighted S&P 500.
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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.