Most ETFs are weighted by market capitalization. It sounds logical enough, giving weight to the biggest and supposedly strongest companies. But history shows that weighting by market cap may not always be the best method.
Over the past year, ETFs using equal- and revenue-weighted methods actually outperformed market cap-weighted funds, reports Will McClatchy for ETFzone.com. Equal and revenue-weighted holdings outperformed the S&P500 by about 20% and 10%, respectively.
Intuitively, weighting by revenue makes sense because bigger revenues usually mean bigger profits and better businesses. Further, market cap doesn’t always reflect a firm’s underlying business value–just look at what happened in the dot-com bubble.
A few funds that use revenue weighting are:
- RevenueShares ADR ETF (RTR)
- RevenueShares Financials Sector ETF (RWW)
- RevenueShares Large Cap ETF (RWL)
- RevenueShares Mid Cap ETF (RWK)
- RevenueShares Navellier Overall A-100 ETF (RWV)
- RevenueShares Small Cap ETF (RWJ)
On the other hand, equal weighting makes sense in the current environment because it gives small-caps and large-caps equal sway in a portfolio. Large-caps serve as economic bellwethers, small-caps outperform in recovery periods. But by weighting all holdings equally, a fund may miss out on true economic activity. A few funds using the equally weighted method are:
- Rydex S&P Equal Weight Consumer Discretionary ETF (RCD), annual fees: 0.5%
- Rydex S&P Equal Weight Consumer Staples ETF (RHS)
- Rydex S&P Equal Weight Energy ETF (RYE)
- First Trust NASDAQ-100 Equal Weight (QQEW)
- ALPS Equal Sector Weight (EQL)
Read the disclaimer: Tom Lydon is a board member of Rydex|SGI.
Sumin Kim contributed to this article.