Rydex, the Maryland-based ETF issuer best known for its equal-weighted S&P 500 ETF, announced today the launch of five new equal-weighted equity ETFs, including both domestic and international funds. Rydex’s growing lineup of equal-weighted ETFs offers an alternative to funds such as SPY or EEM that are linked to market capitalization-weighted benchmarks. Because cap-weighted indexes determine the allocation given to each security based on the company’s market capitalization–and therefore the price of the stock–there is a tendency to overweight overvalued companies and underweight undervalued stocks. Many investors have embraced an equal-weighted strategy as a preferred means of establishing exposure to domestic equities; the Rydex S&P Equal Weight ETF (RSP), which holds the 500 stocks of the S&P 500 in equal weightings, has accumulated more than $2 billion in assets since its launch in 2003. Rydex also offers nine equal weight sector ETFs.
The domestic equity products launching today will be slightly different than RSP, offering equal weights from both a sector and individual security perspective. The indexes linked to the new U.S. equity ETFs feature equal weighting to the nine sectors within the index, as well as equal weighting of individual securities within each sector as well. The international equity ETFs will focus on the individual holdings having an equal weight and do not seek to offer equal exposure to the additional characteristics of either countries or sectors.
Wednesday marks the first day of trading for five Rydex ETFs, with another, the Rydex MSCI All Country World Equal Weight ETF (EWAC), scheduled to launch early in 2011:
- Rydex Russell 1000 Equal Weight ETF (EWRI): This fund, which tracks the Russell 1000 Equal Weight Index, offers investors an equally-weighted alternative to a widely-followed large cap benchmark. Due to the equal sector weighting, this fund offers less exposure to the technology and financial service industries, while providing greater exposure to the materials and utilities sectors than its cap-weighted counterpart Russell 1000. EWRI’s methodology has a dramatic effect on the fund’s weighted median market cap as well; the Rydex fund has a market cap that is roughly one-seventh of what it would be for a market cap weighted fund [see EWRI fact sheet].
- Rydex Russell 2000 Equal Weight ETF (EWRS): This fund tracks the Russell 2000 Equal Weight Index which offers investors equally weighted exposure to small cap U.S. stocks. As a result, this small cap focused index looks to have a much heavier weighting than the traditional index in consumer staples and energy firms while a smaller allocation in both financials and technology. In addition, the fund will initially have a weighted average market cap that is less than half of the cap-weighted Russell 2000 Index [see EWRS fact sheet].
- Rydex Russell Midcap Equal Weight ETF (EWRM): For investors seeking mid cap exposure, EWRM presents a compelling choice by tracking the Russell Midcap Equal Weight Index. The fund invests in 785 securities in total and has an average weighted market cap of just over $4 billion. In terms of sector exposure, the fund has far less than its market cap weighted counterpart in terms of financials and consumer discretionary, but has far more in both the consumer staples and energy sectors [see EWRM fact sheet].
- Rydex MSCI EAFE Equal Weight ETF (EWEF): This fund offers investors the chance to use an equally-weighted methodology to invest in developed markets outside of North America in a single ticker. As of May of 2010, the index offered exposure to 22 different markets stretched across the globe including; Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom [see EWEF fact sheet].
- Rydex MSCI Emerging Markets Equal Weight ETF (EWEM): In another first of its kind, Rydex now offers investors a way to play emerging markets through an equally weighted fund. Currently the two ETFs linked to the cap-weighted MSCI Emerging Markets Index, iShares’ EEM and Vanguard’s VWO, have about $90 billion in assets. EWEM will provide investors with an equal-weighted option for emerging markets exposure, and will actually charge a lower expense ratio (0.65%) than the ultra-popular EEM (0.72%).
Equal Weighting On A Roll
The investment thesis behind equal weighting is relatively straightforward and simple to grasp: by breaking the link between weighting and stock price, the strategy avoids certain features of cap-weighting that can create a drag on returns. And while the weighting methodology employed may seem like a minor decision that won’t have a material impact on bottom line returns, historical performance suggests otherwise. Through November RSP was up about 12.5% on the years. The ultra-popular SPY, which holds the same underlying securities but assigns weightings based on market cap, gained about 7.4% during the same period–a gap of more than 500 basis points over an 11-month time frame.
Equal weighting also enhances the diversification offered relative to cap-weighted funds. The Russell 1000 Index Fund (IWB) offers exposure to a broad basket of securities, but the cap-weighted feature results in top-heavy characteristics; the top 10% of holdings account for more than 50% of assets. In an equal-weighted index, the top 10% of companies would account for about 10% of total assets. “Equal weight ETFs offer a compelling alternative to traditional market cap-weighted ETFs,” said Mike Byrum, chief investment officer, quantitative strategies for Rydex. “Not only do equal weight funds employ a disciplined quarterly rebalance, a practice which can result in selling high and buying low, they also offer increased diversification advantages across the constituents within each index.”
The equal weighting of sectors–a feature of EWRI, EWRS, and EWRM–also offers some relatively simple advantages. Cap weighted indexes will tend to establish larger exposure to sectors in which a bubble is forming (as a recent historical example, all major U.S. equity benchmarks saw their allocations to the tech sector surge in the early 2000s). So indexes that spread exposure equally across various sectors of the economy lessen the potential impact of a crash in any one industry, while the opportunity to participate in a rally in any sector is improved (IWB, for example, would see little benefit from a surge in the underweight materials or utilities sectors). Moreover, an equal sector weighting enhances the diversification benefits of investing in a large basket of underlying securities. ALPS offers an Equal Sector Weight ETF (EQL) alternative to SPY that splits exposure evenly across the nine major sectors of the economy [see Why EQL May Be A Better S&P 500 ETF].
All of the domestic funds charge an expense ratio of 40 basis points. Meanwhile, the funds focused on foreign products charge slightly higher expense ratios of 0.55% for the EFA fund and 0.65% for the emerging markets fund.
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Disclosure: No positions at time of writing.