The Invesco S&P 500 Equal Weight ETF (NYSEARCA:RSP) takes an alternative approach to invest across broad market large-cap equities. In contrast to the S&P 500 Index which is market-cap weighted, RSP holds the same stocks but each position in the same proportion across the portfolio. The equal-weighted strategy has some advantages in terms of diversification by limiting the concentration of the largest companies in the index while adding importance to the smaller holdings.
The key here is to recognize the shift in equity style tilts and differences in its sector allocation. Indeed, RSP is currently outperforming the S&P 500 this year, in part based on its reduced exposure to the tech stocks and an overall more value profile. We like RSP as a high-quality fund based on an investing strategy that is backed by data.
The attraction of RSP is that the equal-weighted strategy ends up addressing several criticisms of the S&P 500, mainly that the index is too "top-heavy" as a handful of companies overwhelm the portfolio. With the same 500 stocks, each underlying holding in RSP represents about 0.2% of the fund. The top 10 holdings in RSP combine to represent 2.5% of the fund weighting compared to 29% in the SPDR S&P 500 Trust ETF (SPY) which we use for reference purposes. This means that an otherwise random stock like Nielsen Holdings Plc (NLSN) and Apple Inc (AAPL) both have a similar weighting in RSP.
The contrast extends down to the sector exposure. Technology stocks represent 15% of RSP, compared to 26% in SPY. On the other hand, other sectors like energy, basic materials, and utilities together representing 14% of RSP are essentially overweighted relative to their 9% allocation in the S&P 500.
The balanced approach from RSP has important implications for its performance relative to the market-cap-weighted S&P 500. In an environment where the mega-cap stocks and technology names are leading higher, RSP should underperform because it has a lower weighting in that group.
Inversely, RSP should stand out during periods where more "value" and defensive type companies are performing well. That's the case we've seen this year with RSP down 9% which is a moderate improvement from the 13% decline in SPY. Simply put, RSP avoiding the concentration in the technology sector along with its overweight positions in outperforming sectors like energy and utilities have helped balance the volatility.
Taking a step back, the data shows that the "regular" market-cap-weighted S&P 500 has still outperformed over the last 5 years. RSP has returned 76% since 2019 compared to 89% in SPY. Investors, likely we're complaining about the large positions in names like Amazon.com Inc (AMZN) and Netflix (FB) when those stocks were generating strong gains, but it's clear now the tables have turned with several high-profile tech leaders currently in a bear market.
What's more impressive is the longer-term trend considering the equal-weighted S&P 500 strategy performance history with the RSP inception date in April of 2003. RSP has returned a cumulative 675% compared to 562% in SPY. Much of this spread opened up from the early gains coming off the financial crisis crash lows going back to 2009.
The other explanation here is that RSP has a larger tilt towards "mid-caps" compared to the market-cap-weighted S&P 500 Index which follows academic evidence that smaller companies tend to outperform over long periods. There is also an aspect between a rotation from growth to value explaining the spread.
We can talk about the performance spread and RSP beating SPY this year on the downside but the reality is that the current market environment is challenging. There are several market headwinds between persistently high inflation and concerns of a slowing economy into a period where the Fed has already signaled its intention for tighter monetary policy. The uncertainties of the ongoing Russia-Ukraine conflict also add a layer of risk to the macro outlook. If the S&P 500 is going to continue trending lower, RSP should also see further declines.
That said, we expect the current trend of narrower volatility from the equal-weighted strategy to persist making RSP a good choice compared to an S&P 500 tracking fund like SPY. We like the RSP's underweight exposure to mega-cap technology names which are particularly sensitive to a deteriorating corporate earnings outlook. At the same time, the overweight exposure to the more value and defensive sectors like utilities and energy should help the equal-weighted strategy to continue outperforming, at least on a relative basis.
The market trading action over the last several months has helped to affirm the importance of diversification which is what the Invesco S&P 500 Equal Weight ETF does well. Recognizing the near-term market headwinds, we officially rate RSP as a hold but maintain an optimistic long-term view. RSP with an expense ratio of 0.2% is a good option for investors to utilize as a core holding in diversified portfolios.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.