However, due to its indexing methodology and greater tilt toward smaller companies, equally weighted index funds display higher risk values. The small company tilt, though, still allows the strategy to capitalize on the overall outperformance of smaller sized companies over the long haul, which has been documented through historic data and academic studies.
Furthermore, there is an innate buy low and sell high type of feature embedded in an equally weighted index. The better returns of an equally weighted strategy is partially explained by the rebalancing effect where stocks are brought back to equal weight by buying low and selling high – outperforming stocks tend to gain in market capitalization so they are sold and the money is then used to buy into underperformers with lower market-caps to bring the equal weight indexing methodology back in line.
ETF investors interested in gaining exposure to an equal-weight indexing methodology may look to something like the recently launched Goldman Sachs Equal Weight U.S. Large Cap Equity ETF (BATS: GSEW), which also comes with a low 0.09% expense ratio.
The Equal Weight U.S. Large Cap Equity ETF tries to reflect the performance of the Solactive US Large Cap Equal Weight Index, which consists of about 500 of the largest U.S. companies and equally weights holdings so that each component is approximately 0.2% of index on rebalance.
Additionally, the Guggenheim S&P 500 Equal Weight ETF (NYSEArca: RSP), which tracks the S&P 500 Equal Weight Index, is the largest equal weight-oriented ETF. 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.