OPINION: Can an index-weighting strategy where each of 11 major market sectors receives equal weight outperform cap-weighting and equal-weighting ones? Columnist MktwHulbert looks into the question.
How much Apple AAPL, +1.30% stock as a percentage of an index fund is right for you: 7.1%; 2.2%, or 0.2%?
Earlier this month I devoted a column to an exchange-traded fund that is benchmarked to the equal-weight version of the S&P 500 — Invesco S&P 500 Equal Weight ETF RSP, +2.69%. Because this ETF gives equal weight to each of the stocks in the S&P 500 index, Apple’s weight is one-500th, or 0.2%. Meanwhile, in the cap-weighted SPDR S&P 500 Trust SPY, +2.21%, Apple stock accounts for 7.1% of the entire portfolio.
How does this hybrid approach perform? Look at the chart above, which plots the relative strength over the past 20 years of the NYSE Equal Sector Weight Index versus the S&P 500. Notice that the NYSE index significantly outperformed the S&P 500 over the first half of this 20-year period, and just as significantly lagged it over the second half. For cumulative 20-year performance, the two are almost precisely neck-and-neck.
Tint says there’s one reason to expect traditional, cap-weighted portfolios to come out on top over the very long term: lower transaction costs. That’s because there is no rebalancing required when maintaining an index fund’s cap weighting. With equal weighting — whether it’s each stock that is equal weighted or each sector — frequent rebalancing transactions must be undertaken to ensure that no stock or sector takes on too much or too little portfolio weight.
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