Most ETFs weight their company holdings in proportion to the
market capitalization (shares outstanding X share price). It
seems logical to think that a company's importance in the economy
is proportional to its perceived value. But historical evidence
suggests that alternative weighting strategies using fundamental
financial ratios often, and perhaps more often, deliver superior
returns.
The easiest, cheapest, and best understood of these types of
ETFs use publicly disclosed weighting methodologie. Investors
today can understandably be a bit skeptical of alternative
weighting schemes which are proprietary "black boxes". Two
transparent weighting strategies are suitable for such investors:
weighting all holdings in equal amounts and weighting based on
revenues. The following graphs shows how both equal and revenue
weighting (RSP and RWL) did quite well over the past year against
an S&P 500 proxy (
SPY
):
Weighting by revenue takes the sensible position that large
and important companies tend to have strong sales. How can they
ultimately make big profits without it? In technology the answer
is often through organic growth, but as the Tech Crash showed
this can often end it tears. Weighting by revenue tends to load
up on companies with large, proven operations and avoids
hype.
This strategy is dominated by the aptly named RevenueShares
line:
- RevenueShares ADR ETF (NYSEArca:RTR), annual fees:
0.49%
- RevenueShares Financials Sector ETF (NYSEArca:RWW),
annual fees: 0.49%
- RevenueShares Large Cap ETF (NYSEArca:RWL), annual fees:
0.54%
- RevenueShares Mid Cap ETF (NYSEArca:RWK), annual fees:
0.54%
- RevenueShares Navellier Overall A-100 ETF (NYSEArca:RWV),
annual fees: 0.6%
- RevenueShares Small Cap ETF (NYSEArca:RWJ), annual fees:
0.54%
- RevenueShares ADR ETF (NYSEArca:RTR), annual fees:
0.49%
- RevenueShares Financials Sector ETF (NYSEArca:RWW), annual
fees: 0.49%
- RevenueShares Large Cap ETF (NYSEArca:RWL), annual fees:
0.54%
- RevenueShares Mid Cap ETF (NYSEArca:RWK), annual fees:
0.54%
- RevenueShares Navellier Overall A-100 ETF (NYSEArca:RWV),
annual fees: 0.6%
- RevenueShares Small Cap ETF (NYSEArca:RWJ), annual fees:
0.54%
RevenueShares ADR ETF (NYSEArca:RTR), annual fees: 0.49%
RevenueShares Financials Sector ETF (NYSEArca:RWW), annual
fees: 0.49%
RevenueShares Large Cap ETF (NYSEArca:RWL), annual fees:
0.54%
RevenueShares Mid Cap ETF (NYSEArca:RWK), annual fees:
0.54%
RevenueShares Navellier Overall A-100 ETF (NYSEArca:RWV),
annual fees: 0.6%
RevenueShares Small Cap ETF (NYSEArca:RWJ), annual fees:
0.54%
These have shown strong performance compared to market cap
equivalent funds dating to 1979 in back testing. Standard &
Poor's verified results back to 1991.
Equal-weighting dampens individual company risk by its very
definition. If 500 stocks are owned in equal amounts, exposure to
failure of one company is about .2% (it strays a bit before
rebalancing), a far cry from the 1%-5% exposure to each of the
top 10 holdings of the S&P 500. But this comes at the price
of losing exposure to true economic activity. Exxon is weighted
the same as First Solar. This effect causes medium sized
companies (by any measure) to predominate and true multinationals
to fall into the minority. An equal weighted version of the
S&P can have an average market cap of just a few Billion
dollars. Equal weighting also emphasizes more fragmented
industries. For instance, financials nearly doubles in
importance.
Equal-weighted ETFs are dominated by the Rydex line,
summarized by the broad Rydex S&P Equal Weight ETF (
RSP
), which weights the S&P 500 equally and sports annual fees
of 0.4%. It's the default choice in this area.
Nine ETFs chop the S&P 500 by industry sector to allow
fine tuning:
- Rydex S&P Equal Weight Consumer Discretionary ETF (
RCD
), annual fees: 0.5%
- Rydex S&P Equal Weight Consumer Staples ETF (
RHS
), annual fees: 0.5%
- Rydex S&P Equal Weight Energy ETF (
RYE
), annual fees: 0.5%
- Rydex S&P Equal Weight Financial ETF (
RYF
), annual fees: 0.5%
- Rydex S&P Equal Weight Health Care ETF (
RYH
), annual fees: 0.5%
- Rydex S&P Equal Weight Industrials ETF (
RGI
), annual fees: 0.5%
- Rydex S&P Equal Weight Materials ETF (
RTM
), annual fees: 0.5%
- Rydex S&P Equal Weight Technology ETF (
RYT
), annual fees: 0.5%
- Rydex S&P Equal Weight Utilities ETF (
RYU
), annual fees: 0.5%
- Rydex S&P Equal Weight Consumer Discretionary ETF (
RCD
), annual fees: 0.5%
- Rydex S&P Equal Weight Consumer Staples ETF (
RHS
), annual fees: 0.5%
- Rydex S&P Equal Weight Energy ETF (
RYE
), annual fees: 0.5%
- Rydex S&P Equal Weight Financial ETF (
RYF
), annual fees: 0.5%
- Rydex S&P Equal Weight Health Care ETF (
RYH
), annual fees: 0.5%
- Rydex S&P Equal Weight Industrials ETF (
RGI
), annual fees: 0.5%
- Rydex S&P Equal Weight Materials ETF (
RTM
), annual fees: 0.5%
- Rydex S&P Equal Weight Technology ETF (
RYT
), annual fees: 0.5%
- Rydex S&P Equal Weight Utilities ETF (
RYU
), annual fees: 0.5%
Rydex S&P Equal Weight Consumer Discretionary ETF (
RCD
), annual fees: 0.5%
Rydex S&P Equal Weight Consumer Staples ETF (
RHS
), annual fees: 0.5%
Rydex S&P Equal Weight Energy ETF (
RYE
), annual fees: 0.5%
Rydex S&P Equal Weight Financial ETF (
RYF
), annual fees: 0.5%
Rydex S&P Equal Weight Health Care ETF (
RYH
), annual fees: 0.5%
Rydex S&P Equal Weight Industrials ETF (
RGI
), annual fees: 0.5%
Rydex S&P Equal Weight Materials ETF (
RTM
), annual fees: 0.5%
Rydex S&P Equal Weight Technology ETF (
RYT
), annual fees: 0.5%
Rydex S&P Equal Weight Utilities ETF (
RYU
), annual fees: 0.5%
They go head-to-head against cap-weighted sector ETFs such as
the Select Sector SPDRs line. The Rydex ETFs deliver substantial
diversification of company-level risk which can be an issue in
typical industry ETFs. Typically Rydex equal weight company
holdings do not exceed 5%.
Another equal-weighted ETF is the First Trust NASDAQ-100 Equal
Weighted ETF (NasdaqGM:QQEW), with annual fees of 0.6%. It is
essentially a collection of large cap stocks which happen to
trade on one US exchange, so it's less than ideal for cleanly
allocating assets. The NASDAQ's propensity for high-tech
companies with good liquidity make it useful for traders and
high-tech investors. And it isn't as popular as the S&P 500
index, so fewer arbitrageurs try to front-run companies soon to
be added or deleted from the S&P.
Co-founder of indexfunds.com, author of two books on
investing, and founder of ETFzone.com, Will has been writing on
indexing issues for 8 years. He holds an MBA from the
University of Texas at Austin.
Co-founder of indexfunds.com, author of two books on
investing, and founder of ETFzone.com, Will has been writing on
indexing issues for 8 years. He holds an MBA from the University
of Texas at Austin.