Do Equal Weight ETFs Perform Better?
If you have spent any time studying ETFs, you probably noticed that Ryder’s Equal Weight S&P 500 ETF (RSP) has consistently outperformed capitalization weighted indices based on the S&P 500 such as the SPDR S&P 500 ETF (SPY). However, there seems to be a relatively simple explanation for this.
The S&P 500 index includes 500 of the most widely held U.S. companies. The index uses market capitalization to determine the relative weighting of its holdings. The largest companies dominate the index. For example, at the time of this writing, the top 10 holdings in the S&P 500 index accounted for 18.73% of the index.
Equal weighting of the S&P 500 has the effect of changing its asset class mix from predominantly large-cap to a mixture of large and mid-cap stocks. Here are Morningstar x-ray views of SPY and RSP.
SPY is 88% large-cap and 12% mid-cap. In contrast, RSP is 54% large-cap, 44% mid-cap, and 2% small-cap. RSP’s mid-cap weighting impacts performance. During periods when mid-cap stocks out perform large-cap stocks, RSP will out perform the S&P 500 index.
The above chart shows the differences in return in 2010 for the equal weight S&P 500 (RSP), Vanguard’s mid-cap ETF (VO), and S&P 500 index. (Note: The returns shown do not include dividends.)
There is no magic to RSP’s return. The equal weighting shifts the asset class composition of the ETF and according changes the total return.