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I do not automatically assume that everyone knows or understands that the S&P500, and indeed its sectors, are capitalization weighted rather than being equally weighted. Although, being color blind, I am not totally enamored of the current fad on “maps” of market sectors, this is one of those times when a graphical representation is the best way of briefly explaining, or showing, how the capitalization weighting employed in the S&P500 (and many other popular indices for that matter) works to skew the influence of one stock over another in the index or the sector. This map of the S&P500 and is from the good folks at finviz.com: (click on any graphic to view full size).
So, for example, Apple (AAPL) makes up a much larger part of the S&P500 than does Dell (DELL) and so changes in its price will have a larger influence on the index. This is what you are buying when you buy the S&P500 ETF SPY, or one of its many clones.
But what if you changed how these stocks are weighted but still included all the stocks in the S&P500? How about if every stock in the S&P500 were to be weighted equally? That’s non-discrimination for you, but apart from that, what impact would it have on returns? We’ll take a look at that in a bit, but you should know that Rydex has such an equally-weighted S&P500 product, ticker RSP where all the stocks in the S&P500 are equally weighted. Please note that the stocks are equally weighted but the sectors are not. RSP follows the S&P 500 equal-weight index (and actually with little tracking error) which S&P describes thusly:
The S&P 500 Equal Weight Index (S&P 500 EWI) is the equal-weight version of the widely regarded S&P 500. The index has the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight.
If you want equally weighted sectors not stocks, and don’t want to do it yourself using the sector SPDRs, ALPS has an ETF of ETFs that will do it for you, their ALPS Equal Sector Weight ETF. On their website ALPS says:
The ALPS Equal Sector Weight ETF (Ticker Symbol: EQL) is an ETF of ETFs that delivers exposure to the US Large Cap Equity market by investing equal proportions in each of the 9 Select Sector SPDRs.
The only problem with EQL is its very low volume, which frankly is a turn-off. SPY counts its daily volume in millions and RSP well into the hundreds of thousands so no worries there.
As to performance, equal weighting of stocks pays off. Over a year,we can see that RSP has a material uplift over SPY. An extra 6% a year isn’t to be sneezed at.
Shown graphically in TC2000 chart we can see how closely EQL actually sticks to SPY but RSP’s overperformance is plain to see:
For the year to date things are a bit closer but RSP still has the lead, and it’s enough to make a difference:
But how about in the recent/current correction? EQL edges out a lead here but in practical terms it looks as if RSP does better for us in down markets than the standard equity weighted SPY, and again by enough to make a difference.
Over a two and five year period, the comparison graphs look like this (EQL excluded from the 5-year as it hasn’t been around that long):
CONCLUSION: From the 5-year chart we can see that RSP doesn’t always outperform SPY, but based on recent experience, and the fact that over five years RSP roughly doubles the performance of the S&P500 while still investing in the same portfolio group, it looks as if it would be hard to exclude it from consideration in portfolio design.
PLEASE NOTE: PALADIN MONEY REVIEWS ARE FOR EXPERIMENTATION, EDUCATION, ILLUSTRATION AND DISCUSSION ONLY. THEY ARE NOT SOLICITATIONS TO PURCHASE SECURITIES OR INVESTMENT RECOMMENDATIONS
