Potential Headaches for Traditional Cap-Weighted Index ETF Investors

Alternatively, ETF investors can diminish risks posed by traditional market cap-weighted indexing methodologies by looking at alternative index-based ETF strategies.

For instance, the obvious alternative to solve potential risks posed by overweighting due to the rising market cap of the technology segment is through an equal weight index-based strategy, such as the Guggenheim S&P 500 Equal Weight ETF (NYSEArca: RSP), which tracks the S&P 500 Equal Weight Index.

The underlying S&P 500 Equal Weight Index is the equal weight version of the S&P 500 Index. The equal-weight index contains the same component holdings as the cap-weighted S&P 500, but each company in the S&P 500 Equal Weight Index is allocated the same weight at each quarterly rebalance. Consequently, the holdings are balanced across all of the S&P 500 companies evenly over time. In contrast, the market cap-weighted S&P 500 Index overweights the 50 largest companies with close to 50% of the holdings.

Because of its indexing methodology, RSP only holds a 13.3% tilt toward the technology segment and holds an overweight 16.1% position in consumer discretionary. Furthermore, due to its equal weight focus, it will lean toward smaller names, with mid-caps making up 48.3% of the fund’s portfolio, followed by 39.5% large-caps and 11.0% mega-caps.