There are some years when equal-weighted ETFs are your best friend, and other years where they disappoint. I thought of this axiom as I was taking a look at one of these equal-weighted funds, the SPDR Morgan Stanley Technology ETF (MTK)
Just to review, most ETFs use a modified-capitalization weighted index, giving larger companies more weight in their index. With equal weighting, however, the smaller stocks have a lot more impact on your returns.
But this ETF is only “equalized” (rebalanced) once per year, near the end of December, so the weightings of stocks that do well tend to exceed those that don’t do so well as the next several months go by.
Here’s a look at the weighting of this fund as of May 3, 2011
Note how you see some smaller companies at the top of the list while some larger companies occupy the bottom tier.
(Incidentially: Wow! A tech fund where Apple (NASDAQ:AAPL
) is less than 3% of the holdings! Hey, I like AAPL, but I like some of the smaller companies too)
) at the top of the list has a weighting that’s 70% more than the last-place company, RIMM. That’s because NVDA has performed a lot better than RIMM since the MTK fund was last rebalanced on December 17. 2010.
Just for fun, I did a thought experiment. What if on December 17 I’d purchased $10,000 in each of the top five companies and shorted $10,000 worth of the bottom five companies?
Here’s that would have turned out as of May 3, 2011
The chart at the top shows hypothetical returns for both the long side, the short side, and the combined results. The chart at the bottom shows a hypothetical $50,000 invested in the MTK fund itself against both SPY
Outperformance the rest of the year?
Obviously, I would have had no way to know ahead of time which stocks would be the under- and over-performers, but if both groups continue as they’ve traded, this fund could probably do well as the leaders get weighted more heavily and the laggards are given less weight – until the fund next rebalances on December 16. 2011.
If tech or the overall market slides, of course, all bets are off. But here’s a look at how MTK has performed in the past after its rebalancing for selected years. There are some years when the fund seems to lag, while in other years it roars into year's-end until another equal-weighted rebalancing.
Ways to trade with MTK
If you believe the laggards, such as CSCO
and RIMM, will continue underperforming the leaders, such as NVDA
, you might think about buying MTK. If you’re aggressive, you might also short some of those stocks toward the bottom of the list. Just don’t forget that the fund will rebalance near the end of December.
Or forget the fund entirely and pair up some of those leaders and laggards in various long/short combos to fit your view. Toward the middle of the year, a look at the weightings of a fund like this can provide some good long/short ideas if you’re so inclined.
One thing I would not do is try and short MTK as any sort of a hedge. It’s a thinly traded ETF with an average volume for the past three months of only 15,500 shares. I’m surprised the fund still even exists at all.
But I’m glad it does. I like equal-weighted sector ETFs, but I don’t own this one. When smaller stocks tend to shine brighter than the big heavyweights, these types of funds offer a great way to take a diversified position in a specific sector.
Disclosure: I am long CSCO, AAPL, IBM, ORCL, INTC.