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Study after study has proved plain-vanilla index funds such as the SPDR S&P 500 ETF (SPY) beat actively-managed mutual funds in the long run. There may be a way to beat the S&P 500 at its own game — equal-weighting its stocks holdings.
The market-cap weighted SPDR S&P 500 ETF (SPY) holds stocks based on the total market value of their shares. It’s like making a fruit salad with one of each fruit: one watermelon, one honeydew, one apple and one grape. The sheer size of the watermelon, or the biggest stock, dwarfs the smaller components. Whereas an equal-weighted fruit salad or index holds the same amount of each fruit. In turn, you get less exposure to the big stocks and more exposure to the small ones.
The Invesco Equally-Weighted S&P 500 Fund (VADAX) is the only fund of its kind with a 15-year track record. It returned 8.7% annualized over the past 15 years, surpassing the SPDR S&P 500 ETF (SPY), which returned 6.7% on average over the equivalent period.
|Historical Returns of Equal-Weighted ETFs and Mutual Funds Vs. SPDR S&P 500 ETF (SPY)|
|Name||Ticker||% Total Return 12 Month||% Total Return 5 Year||% Total Return 10 Year||% Total Return 15 Year||% Dividend Yield TTM||Beta 3 Year||mil$ Market Cap|
|Guggenheim S&P 500® Equal Weight ETF||RSP||15.42||14.92||7.94||—||1.2||1.03||22,775.09|
|Index Funds S&P 500 Equal Weight No Load||INDEX||15.38||—||—||—||1.13||—||21,673.46|
|Invesco Equally-Wtd S&P 500 A||VADAX||15.1||14.71||7.8||8.69||1.03||1.03||22,384.90|
|iShares MSCI USA Equal Weighted||EUSA||14.98||13.92||—||—||1.59||1.05||19,010.35|
|PowerShares Russell 1000 Equal Wght ETF||EQAL||16.51||—||—||—||1.57||—||11,207.23|
|SPDR® S&P 500 ETF||SPY||12.86||14.39||6.97||6.55||2.03||1||79,652.24|
|Source: Morningstar as of Jan. 3, 2017|
“Those who rely on capitalization-weighted index funds end up making big sector bets they didn’t necessarily want,” says Craig Birk, executive vice president of portfolio management at Personal Capital. The San Carlos, Calif.-based firm oversees $3.4 billion in assets.
Birk recommends having equal-weighted exposure to all sectors. Citing research conducted by Russell Investments in 2010, Birk says equal-weighted indexes offer bigger returns long term with less volatility compared to market-cap weighted indexes. This was seen in small-, mid- and large-cap U.S. indexes as well as foreign development markets and emerging markets.
“Those who try to guess the best sectors for next year are more likely to be wrong than right,” Birk says. “Take the recent election for example. The consensus was that if Donald Trump won the election, it would be a boon for health care stocks. But instead, health care is lagging the broader market.”
CFRA, a global independent equity research firm, has an overweight rating on the Guggenheim S&P 500 Equal Weighted ETF (RSP).
“With gains for the market-cap weighted S&P 500 being more limited in 2017, an equal-weighted approach that has reduced exposure to some of 2016 winners is a prudent approach,” Todd Rosenbluth, director of ETF research at CFRA, said in an email.
A Simpler and Better Way to Index
It appears the Index Group in Colorado Springs, Colo. followed the adage “if you can’t beat them, join them” in launching the Index Funds S&P 500 Equal Weight (INDEX) in April 2015. The mutual fund currently has $8.1 million in assets and charges a 0.3% annual expense ratio.
He added: “This is in stark contrast to the market-cap, version which uses a complex formula that winds up allocating over 50% of the portfolio to only 50 companies.”
“A key benefit of index investing is the peace of mind factor,” Willis wrote in a commentary. “ Since no one knows the future, why second guess it or attempt to time it? An index portfolio manager’s read on current market conditions doesn’t matter, as their job is to track the index and ignore everything else.”