Investors often hear about the benefits of diversification. On the other hand, market participants also see headlines and articles pertaining to small numbers of equities leading markets higher.
That was the case in the first quarter when a scant number of S&P 500 member firms accounted for roughly 90% of the index’s upside. Even when accounting for the 2022 slump in stocks, the top five holdings in the S&P 500 account for more than 21% of the index’s weight – a percentage that’s at the higher end of historical levels.
One way of looking at that scenario is that supposedly broad-based index funds and exchange traded funds aren’t offering investors the diversification benefits they’re looking for. Another point market participants should remember is that the aim diversification isn’t as much about generating upside as it is building a foundation of portfolio protection.
“The goal of diversification is not necessarily to boost performance—it won't ensure gains or guarantee against losses,” according to Fidelity. “Diversification does, however, have the potential to improve returns for whatever level of risk you choose to target.”
With that in mind, here are some stock-based ETFs for diversification buffs.
Direxion NASDAQ-100® Equal Weighted Index Shares (QQQE)
As its name implies, the Direxion NASDAQ-100® Equal Weighted Index Shares (QQQE) is the equal-weight answer to cap-weighted Nasdaq-100 Index (NDX). QQQE follows the NASDAQ-100 Equal Weighted TR Index – NDX’s equal-weight cousin.
When QQQE rebalances, its 100 components receive weights of 1% apiece. Contrast that with cap-weighted counterparts that allocated nearly a quarter of their respective weights to just Microsoft (MSFT) and Apple (AAPL). In other words, each QQQE component is as important as the next. QQQE offers investors at least two primary benefits.
“Broader diversification beyond technology sector stocks which may help reduce concentration risk,” according to Direxion. “Greater performance contribution from companies with smaller market capitalization.”
Invesco S&P 500® Equal Weight ETF (RSP)
Arguably the godfather of guaranteed equity diversification in the ETF wrapper, the Invesco S&P 500® Equal Weight ETF (RSP) has making good on the promise of diversification for two decades. The $34.16 billion ETF turns 20 years on April 24.
RSP actually refutes one of the claims critics lob at the equal-weight methodology, which is that it’s heavily dependent on value investing. RSP allocates just a third of its weight to value stocks and that assertion doesn’t explain how the fund generated out-performance during a lengthy run of growth beating value up until 2021.
“RSP has the same holdings as the S&P 500 Index, but each company is weighted equally to help you diversify,” according to Invesco. “With the S&P 500 Equal Weight Index, you still get exposure to the largest 500 public U.S. companies in the S&P 500 Index. However, each company is weighted at 0.2%, providing you with more diversification and less concentration.”
ALPS Equal Weight Sector ETF (EQL)
The ALPS Equal Weight Sector ETF (EQL) is a pertinent choice for investors looking for sector-level diversification. With technology still representing more than a quarter of the cap-weighted S&P 500, investors can hardly be blamed for desiring some sector diversity.
EQL uses an efficient approach to accomplish its objective and contain costs. It equally weights the 11 sector SPDR ETFs rather than actively managing sector exposures.
Those are large-cap funds meaning EQL is a large-cap ETF. It’s ability to outperform the broader market shines when defensive and value stocks are in style and/or high-growth sectors are faltering.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Todd Shriber
Todd Shriber got his start in financial markets as a reporter with Bloomberg News. Later, he became a trader at a Southern California-based long/short hedge fund where he specialized in trading sector and international ETFs leading up to and during the financial crisis. He would later become the web editor at ETF Trends. Currently, he analyzes, researches and writes on ETFs for a variety of Web-based publications and financial services firms.Shriber has been quoted in the Barron's, CNBC.com and the Wall Street Journal. His work has been published on Web sites such as Benzinga, ETF Daily News, ETF Trends, MarketWatch, Fox Business and Nasdaq.com.
Read Todd's Bio