Weighting stocks by market capitalization is said to be a gauge of market participants’ collective wisdom. And the methodology has served investors. But there’s also something to be said for the equal-weight way of doing things.
Many advisors and investors are familiar with ETFs that equally weight stocks. But the ALPS Equal Sector Weight ETF (EQL ) features a different spin. Rather than emphasizing equally proportioned stocks, the $641 million EQL equally weights the 11 GICS sectors by way of the corresponding Sector SPDR ETFs.
That is to say EQL is underweight growth sectors like technology and communication services relative to the cap-weighted S&P 500. From that it can be inferred that EQL has more of a value feel. That’s a common trait among equal-weight funds. Related to the value factor, EQL deserves some credit. That’s because over the past three years, the ALPS ETF beat the Russell 1000 Value Index by 710 basis points. Simultaneously, it sported the same level of annualized volatility.
EQL Can Alleviate Concentration Risk
Concentration risk is arguably the primary reason why equal weighting has garnered more attention over the past few years. The result of a small number of tech and communication services stocks taking on an outsized percentage of the S&P 500 means those two sectors now combine for 41% of the gauge’s weight. That implies EQL can make sense as complement to broad-based, cap-weighted funds.
“High levels of concentration in an index obviously entail a considerable risk. For example, in the case of a price correction for just one or two of these mega caps, also known as the Magificent-7,” noted Daniel Dornel of BNP Paribas. “Investors have come to realise that an equal-weighted investment approach can offer portfolio diversification from the Magnificent 7 and as well as US equities generally.”
EQL also offers utility as a potential pairing with international funds. That’s because many global funds, which include U.S. and foreign stocks, tilt too heavily into domestic equities.
“Investors have come to realise that an equal-weighted investment approach can offer portfolio diversification from the Magnificent 7 and as well as US equities generally,” added Dornel. “Even more impressively, out of the 23 countries in MSCI World, the US represents around 75% of the universe. We note the weight of the US has also been increasing significantly over the last decade.”
Bottom Line
Investors looking to reduce dependence on mega-cap tech stocks could be well-served by considering ETFs such as EQL.
“We believe this underscores the potential benefits of an equal-weighted approach to a global investment universe. It can create a more balanced portfolio with greater diversification while maintaining some exposure to a large market such as the US,” concluded Dornel.
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