Rydex, the issuer behind the ultra-popular S&P Equal Weight ETF (NYSEARCA:RSP), announced this week the introduction of two new ETFs that offer equal-weighted exposure to the S&P MidCap 400 Index and S&P SmallCap 600 Index. The new ETFs include:
Each will each offer exposure to the same basket of securities included in the popular market-cap weighted equity indexes. But instead of assigning weights to individual securities based on market capitalization, each stock will receive an equivalent weighting in the underlying index.
Equal Weight 101
Rydex was a pioneer in the development of equal-weighted indexes, and now offers 18 ETFs linked to equal-weighted benchmarks. By far the most popular of those is RSP, which offers an alternative for large cap U.S. equity exposure. That fund, which has more than $3 billion in assets, includes all components of the S&P 500. But unlike SPY, the Rydex version assigns an equal weight (about 0.2% of the portfolio) to each component company upon rebalancing.
Investors who have embraced equal weighting cite several potential advantages. First, the methodology steers clear of perhaps the biggest drawback of cap weighting: A tendency to overweight overvalued stocks, and vice versa. Equal weighting also avoids the construction of “top heavy” funds that rely on a small handful of stocks for a majority of the underlying portfolio. Of course, there are some potential disadvantages as well. Equal weighted ETF tend to be more expensive, and the regular rebalancings can potentially limit the tax efficiencies of the exchange-traded structure.
The impact of the seemingly minor difference between these two approaches has turned out to be quite significant. In 2010, RSP beat its cap weighted counterpart by about 600 basis points. And in the second quarter of 2011, RSP beat SPY for the tenth consecutive quarter.
The introduction of EWMD and EWSM gives investors options for rounding our exposure to U.S. equities using an equal weight methodology. A portfolio that utilizes RSP in connection with the recently-launched products would include about 1,500 individual securities without giving any a weight of more than about 0.25%.
Equal Weight ETFs
Rydex also maintains a lineup of equal weight sector ETFs, as well as equal weight funds covering emerging markets (NYSEARCA:EWEM) and the EAFE region (NYSEARCA:EWEF). In late 2010, Rydex also introduced ETFs linked to equal-weighted versions of Russell indexes, including the Russell 1000 Equal Weight ETF (EWRI), Russell 2000 Equal Weight ETF (EWRS) and Russell MidCap Equal Weight ETF (EWRM). Those Russell-linked equal weight products take a slightly different approach. Each sector of the economy (e.g., financials, energy, etc.) is assigned an equal weight within the portfolio, and within each sector component securities are assigned an equivalent allocation.
State Street also offers a number of equal-weighted ETFs, including the S&P SPDR Telecom ETF (XTL). ALPS offers the Equal Weight Sector ETF, which is comprised of equal holdings in each of the nine sector SPDRs.
There are currently three ETFs linked to the cap-weighted version of the MidCap 400 with more than $20 billion in aggregate assets. The cap-weighted version of the SmallCap 600 Index is also covered by three separate ETFs; IJR, SLY and VIOO have more than $7 billion in combined AUM.
Disclosure: No positions at time of writing.
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