Equal-weight ETFs provide a compelling alternative to the traditional market-cap-weighted structure, as each component of the index receives an equal weighting in the portfolio. For investors wanting more diversified exposure to the components in an index, equal weighting can be a simple low-cost solution.
Defining Equal-Weight ETFs
An equal-weight ETF is a type of exchange-traded fund that follows an investment strategy where all the components of the underlying index or portfolio are given equal allocation weights. In contrast, traditional market-cap-weighted ETFs give a higher weighting to larger companies, while smaller companies have a lower weighting.
By providing equal exposure to all the constituents, these ETFs can capture the potential growth of smaller companies that might be overlooked in market-cap-weighted strategies. Thus, equal-weight ETFs are often used by investors who value diversification and believe in the potential of smaller companies to perform as well or better than larger ones, especially in the long run.
Cap-Weighted ETFs vs Equal-Weight ETFs
Cap-weighted ETFs and equal-weight ETFs differ primarily in how they allocate their holdings and the resulting exposure they provide to different stocks or securities. This creates related differences in portfolio characteristics, rebalancing frequency and performance.
Here are the key differences between cap-weighted and equal-weighted ETFs:
Weighting Methodology and Index Construction
- Cap-weighted ETFs: Also known as market-weight ETFs or market-cap-weighted ETFs, these ETFs allocate higher weights to stocks or securities with larger market capitalizations. This means that companies with higher market values have a greater impact on the ETF's performance.
- Equal-weight ETFs: Equal-weight ETFs allocate the same weight to each stock or security in the underlying index or portfolio, regardless of their market capitalization. Every company has an equal opportunity to influence the ETF's performance.
Portfolio Characteristics
- Cap-weighted ETFs: These ETFs tend to be more top-heavy, meaning that larger companies with higher market capitalizations have a greater influence on the ETF's performance. This structure also tends to increase allocations to certain sectors over others.
- Equal-weight ETFs: Equal-weight ETFs offer a more balanced exposure across all the components of the index or portfolio. They provide greater representation to smaller and midcap companies, potentially capturing their growth opportunities.
Rebalancing Frequency
- Cap-weighted ETFs: These ETFs require less frequent rebalancing since the weights of stocks or securities change naturally and their market capitalizations don’t fluctuate significantly.
- Equal-weight ETFs: Equal-weight ETFs require regular rebalancing to maintain the equal weight allocation. As prices and market capitalizations change, the ETF's holdings are adjusted to ensure each stock maintains an equal contribution to the overall portfolio.
Performance Characteristics
- Cap-weighted ETFs: Market-cap-weighted ETFs tend to be more influenced by the performance of large cap stocks since these stocks have a higher weighting. Thus, the performance of the index is more closely tied to the performance of the largest companies.
- Equal-weight ETFs: Equal-weight ETFs may provide more exposure to smaller and midcap companies, potentially capturing their outperformance. The performance of individual stocks has a more equal impact on the ETF's overall performance.
What Is an Equal-Weight S&P 500 ETF?
An equal-weight S&P 500 ETF is an exchange-traded fund that aims to replicate the performance of the S&P 500 Equal Weight Index. It provides investors with exposure to all the stocks in the S&P 500 index while allocating an equal weight to each constituent. This index provides an alternative weighting methodology to the traditional market-cap-weighted S&P 500 index.
By investing in an equal-weight S&P 500 ETF, investors gain exposure to the entire S&P 500 universe but with a different weighting approach. This means that the smaller companies have an equal opportunity to impact the ETF's performance, potentially providing a more diversified and balanced investment compared to the market-cap-weighted S&P 500 ETFs.
What Is the S&P 500 Equal-Weight Index?
The S&P 500 Equal-Weight Index (EWI) was first introduced on Jan. 4, 2003, by Standard & Poor's. It was created as an alternative to the traditional market-cap-weighted S&P 500 index, providing investors with an equal-weighted representation of the constituent stocks. The concept of equal-weighting methodology gained popularity as a way to address some of the limitations of market-cap-weighted indexes.
Since its inception, the S&P 500 EWI has gained recognition as an important benchmark for evaluating the performance of equal-weighted investment strategies. The index has undergone several rebalancing and methodology enhancements over the years to maintain its relevance and accuracy.
The Largest Equal Weight ETFs
The largest equal-weight ETFs, as measured by AUM as of July 10, 2023, are:
| Ticker | Fund | AUM (Billions) | Expense Ratio |
| RSP | $39.52 | 0.20% | |
| XBI | $6.17 | 0.35% | |
| GNR | $3.20 | 0.40% | |
| XOP | $3.11 | 0.35% | |
| RSPT | $3.01 | 0.40% | |
| KRE | $2.91 | 0.35% | |
| SKYY | First Trust Cloud Computing ETF | $2.84 | 0.60% |
| FNGU | Microsectors FANG+ Index 3x Leveraged ETN | $2.45 | 0.95% |
| XME | $1.78 | 0.35% | |
| XSD | $1.54 | 0.35% |
The Advantages of Investing in Equal-Weight ETFs
Investing in equal-weight ETFs offers several advantages, including diversification and potential for higher returns.
Advantages of equal-weight ETFs include:
- Diversification: Equal-weight ETFs provide a more balanced exposure to all the components of the underlying index or portfolio. By allocating an equal weight to each security, these ETFs inherently offer diversification across different companies or sectors, potentially reducing concentration risk.
- Potential for outperformance: Equal-weight ETFs can capture the potential growth of smaller or midcap companies that might be overlooked in market-cap-weighted strategies. By providing equal exposure to all constituents, these ETFs offer a chance to benefit from the performance of companies that have higher growth potential.
- Rebalancing opportunities: Equal-weight ETFs typically rebalance their holdings periodically to maintain the equal-weight allocation. This rebalancing process can potentially enhance returns by selling overperforming stocks and buying underperforming stocks, effectively buying low and selling high.
The Disadvantages of Investing in Equal-Weight ETFs
Although equal-weight ETFs have multiple advantages, investors should also consider their disadvantages, including higher turnover and related costs, and potential for higher volatility.
Disadvantages of equal-weight ETFs include:
- Higher turnover and transaction costs: Equal-weight ETFs require frequent rebalancing to maintain the equal-weight allocation, which can result in higher turnover and transaction costs. This may impact the ETF's expenses and potentially lead to higher capital gains distributions.
- Potentially higher volatility: Equal-weight ETFs can have higher volatility compared to market-cap-weighted ETFs due to their exposure to smaller and midcap companies. Smaller companies tend to have greater price volatility, which can translate into increased volatility for the ETF.
- Lower exposure to industry leaders: Market-cap-weighted ETFs naturally allocate a larger portion of their portfolio to industry leaders and megacap stocks. By investing in equal-weight ETFs, investors may have a relatively lower exposure to these dominant companies, potentially missing out on higher returns when these stocks are in favor.
The Bottom Line of Equal-Weight ETFs
Equal-weight ETFs offer a more diversified alternative to traditional ETFs, which are commonly market-cap-weighted. This is because equal weighting assigns the same allocation percentage to all the components of a given index, rather than higher allocations to the largest components. As always, investors should carefully assess the characteristics and performance of these unique ETFs before making investment decisions.
