The Equal Weight Alternative

By William Belden

While there has been a proliferation of index-based products designed to offer beta solutions across market segments, not all index-based products are created equally. Equal weight strategies generate unbiased exposure to market risk factors, providing potential for enhanced risk control and opportunity to capture long-term equity outperformance.

Equal weight investing is a smart beta strategy that does exactly what its name implies - it equally weights every stock in the strategy regardless of its market capitalization. In contrast to traditional cap-weighted approaches - where each stock is weighted based on its size (or market capitalization), potentially resulting in increased concentration risk - equal weight investing creates unbiased exposure to all stocks. No one stock is more important than any other. Equal weighting can be applied to broad market indices, such as the well-known S&P 500^® Index, as well as to sectors.

Balanced Exposure-Reducing Overconcentration

Equal weighting offers balanced exposure across all the stocks in an index, not just the largest capitalization stocks. Investors who want to invest in a broad market index, but don't want their investment to be dependent on the performance of the largest capitalization companies, may find an equal weight strategy attractive for reducing overconcentration risk relative to traditional market cap weighting and broadening return potential. The chart below shows the dramatic difference between the two weighting strategies in terms of stock composition.

Disciplined Rebalancing - "Buy Low, Sell High"

Disciplined rebalancing may also contribute to outperformance for equal weight strategies, as equal weight allocations are regularly rebalanced back to their equal weight status. This dynamic approach eliminates emotional attachment to stocks that experience price run-ups and offers a contrarian perspective via a buy low/sell high discipline. The majority of S&P 500^® equal weight outperformance versus the S&P 500^® Index (cap-weight) can be attributed to the disciplined quarterly rebalancing.

Equal Weight in an ETF Format for Tax Efficiency

One concern about equal weight investing is the potential tax consequences of the turnover associated with quarterly rebalancing. However, incorporating an equal weight strategy within an ETF structure may offer tax advantages over open-end mutual funds.^[1] Due to their unique creation-redemption process, ETFs typically do not trade shares of their underlying portfolio for cash. Therefore, shareholders generally do not realize capital gains until they sell their ETF shares.

The growth of equal weight strategies has been fueled by demand from advisors and investors seeking opportunities in diverse markets. Equal weight has grown in interest and its application should continue to provide a compelling alternative to a market cap-weighted approach for both core and tactical positions in investor portfolios.

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^[1] It is important to note that there are some mutual funds managed with the goal of achieving tax efficiency and/or low expense ratios.

The broad diversification of equal weight strategies does not assure a profit or eliminate the risk of loss. When large cap securities are in favor or in severe market downturns, an equal weight strategy may under perform a cap-weighted strategy. Increased exposure to smaller companies may increase volatility, and equal weight strategies could have higher portfolio turnover than cap-weighted strategies.

Read a fund's prospectus and summary prospectus (if available) carefully before investing. It contains the fund's investment objectives, risks, charges, expenses and other information, which should be considered carefully before investing. Obtain a prospectus and summary prospectus (if available) at GuggenheimInvestments.com or call 800.820.0888.

Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management.

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