Equal Weight ETFs Offer a 'Compelling and Rich' Alternative to Standard Cap Weighting

by: Gary Gordon

The early 80s may accurately capture my transition to adulthood. Yet the 70s have a grip on a treasure trove of childhood memories — from iZod shirts to Schoolhouse Rock to the Dallas Cowboy Cheerleaders.

The 70s also bring back a less nostalgic activity… waiting on gasoline lines that stretched about a 1/2 mile down Route 22. Well, to be fair, it was my father that was in the driver’s seat. Nevertheless, I had to hear about it!

I bring this up now because Energy ETFs have been the hottest month-over-month investments around. And because the best of the broad-based performers in the space is a sparsely employed equal-weight ETF, Rydex Equal Weight Energy (NYSEARCA:RYE).

Month-Over Month For Broad-Based Energy ETFs (11/8/10-12/7/2010)
Approx %
Rydex Equal Weight Energy (RYE) 7.1%
Vanguard Energy (NYSEARCA:VDE) 6.2%
SPDR Select Energy (NYSEARCA:XLE) 5.6%

For those that track the differences between equal-weight indexes and market-cap indexes, the news may not be all that shocking. In fact, there is evidence to show that the results often hold up over longer periods of time as well. For instance, take a look at the 1-year returns for broad-based Tech ETFs.

Year-Over-Year For Broad-Based Technology ETFs (12/8/09-12/7/2010)
Approx %
Rydex Equal Weight Technology (NYSEARCA:RYT) 23.2%
iShares DJ Technology (NYSEARCA:IYW) 15.8%
SPDR Select Technology (NYSEARCA:XLK) 13.2%

Or Materials ETFs:

Year-Over-Year For Broad-Based Materials ETFs (12/8/09-12/7/2010)
Approx %
Rydex Equal Weight Materials (NYSEARCA:RTM) 22.5%
Vanguard Materials (NYSEARCA:VAW) 21.5%
SPDR Select Materials (NYSEARCA:XLB) 17.4%

Or even the S&P 500:

Year-Over-Year For S&P 500 ETFs (12/8/09-12/7/2010)
Approx %
Rydex Equal Weight S&P 500 (NYSEARCA:RSP) 20.7%
SPDR S&P 500 Trust (NYSEARCA:SPY) 12.5%
iShares S&P 500 (NYSEARCA:IVV) 12.5%

One of the reasons that equal-weight indexing often outperforms market-cap indexing may be attributable to the nature of quarterly rebalancing. Equal-Weight ETFs like those at the Rydex Fund family rebalance quarterly… so that all components have the same effect on the overall asset’s movement. This has the inherent effect of selling high and buying low (i.e., selling the leaders higher while buying the laggards at lower prices).

In spite of the evidence that equal-weighting may add value, the lower trading volume on Rydex products may make some folks more squeamish. Thin volume can sometimes make it harder to get in or get out a desired price point.

Still, it’d be foolish to look past the Rydex family’s fund line-up. In fact, 5 more equal-weight Rydex vehicles launch on 12/8/2010, including:

Rydex Russell 1000® Equal Weight ETF (EWRI)
Rydex Russell 2000® Equal Weight ETF (EWRS)
Rydex Russell Midcap Equal Weight ETF (EWRM)
Rydex MSCI Emerging Markets Equal Weight ETF (NYSEARCA:EWEM)

Now, I’m not hear to tell you that these new ETFs will be sure-fire winners. Market volatility may have a lot to say about the success or lack of success going forward. I will tell you that there’s a “compelling and rich” argument to expect Rydex MSCI Emerging Markets Equal Weight ETF (EWEM) to out-hustle iShares MSCI Emerging Markets (NYSEARCA:EEM) over time; there’s an equally compelling reason to believe that Rydex Russell 2000 Equal Weight ETF (EWRS) may just nip iShares Russell 2000 (NYSEARCA:IWM) as well.