Next time you’re speaking with your accountant, investment adviser or other financial professional, ask them:
“Can you beat the S&P 500 with the S&P 500?”
They might look at you a little funny. But, my personal interactions tell me most will respond “no.”
That’s the wrong answer because it’s doable.
But admittedly, it’s sort of a trick question.
The twist is there are two different S&P 500s with the same 500 stocks. But their construction is very different.
There’s the good old S&P 500 Index that everyone knows about, which is the capitalization-weighted version.
Yet, there’s also the equal-weighted version of the S&P 500 Index.
The S&P 500 Equal Weight Index includes all the same constituents as the S&P 500 Index. But there is one significant difference. Each company is allocated a fixed weight of 0.2%.
So, while the standard S&P 500 Index has 19% of its weight devoted to its top 10 names, you’d have to go 95 names deep in the S&P 500 Equal Weight Index to match that same 19% weight.
For example, Apple has a 3.7% weight in the S&P 500 Index (cap-weighted). But, in the S&P 500 Equal Weight Index, Apple has the same 0.2% weight as Illumina, NRG Energy, Skyworks Solutions and all the other constituents in the index.
In 2003, Guggenheim launched the original strategic beta ETF, the Guggenheim S&P 500 Equal Weight ETF (RSP). That’s the first ETF to abandon a market-cap-weighted approach and embrace an alternative-weighting strategy in the form of equal weighting.
Generally speaking, a cap-weighted index overweights the overpriced and underweights the underpriced. With an equal-weighted index, this problem is avoided.
Related story: Use This ETF Tag Team to Beat the S&P 500
William Belden, head of ETF Business Development for Guggenheim, says:
Historically, equal-weight strategies could only be accessed in the institutional marketplace.
Today, with the growth of index-based solutions, the equal-weight approach has gained favor among investors seeking opportunities across multiple capitalizations and geographic regions.
Equal-weight portfolios do not favor a particular group of stocks, sectors, or other market performance factors based on fundamentals or forward-looking projections. Allocations are broadly distributed, providing greater representation of index constituents. Perhaps most importantly, these allocations are regularly rebalanced back to their equal weights.
At the end of the day, it always comes down to performance. And this ETF shines in that area.
The equal-weighted version of the S&P 500 Index has demonstrated a high likelihood of beating the cap-weighted version of the S&P 500 Index each year — and an even-higher probability of beating it over the longer term.
That means not only can you win a bet, but this strategy modification can improve your investment returns from this point forward.
From 2000 to 2016, the S&P Equal Weight Index outperformed the S&P 500 Index in 13 of 17 calendar years. That’s 77% of the time.
And the outperformance adds up over time …
Over the last 17 years, the S&P 500 Equal Weight Total Return Index (SPXEWTR in chart) returned +314% while the S&P 500 Total Return Index (SPXT in chart) returned +112%.
That’s almost three times the return … just from equally weighting stocks instead of weighting them by market cap.
RSP’s consistent track record of outperformance also validates choosing equal weight over cap weight.
Average Annualized Returns for Rolling Monthly Periods (through 3/31/17)
% of Time RSP Outperformed S&P 500 Index for Rolling Monthly Periods (through 3/31/17)
RSP has impressively outpaced the S&P 500 Index for 100% of rolling monthly periods over the last 10 years! It’s also decisively outpaced the cap-weighted S&P 500 Index over one- (59%), three- (74%) and five-year (83%) periods.
As Guggenheim’s Belden told me:
The reduction in concentration risk — combined with a quarterly rebalance — has helped RSP frequently outperform the S&P 500 since the fund’s 2003 inception on a rolling basis. And RSP has never distributed a cap gain since its inception 14 years ago.
The direct link between prices and weights is pointed out by critics of market-cap-weighted indexes as the main source of potential drag on their returns, as it might result in overweighting overvalued companies and underweighting undervalued companies.
Equal weighting severs the link between a stock’s price and its weight in the index in the simplest possible way.
RSP was the first ETF to introduce a smart beta methodology when it debuted 14 years ago. Its remarkable history of outperformance confirms that simplicity works.
The Guggenheim S&P 500 Equal Weight ETF (NYSE:RSP) was unchanged in premarket trading Wednesday. Year-to-date, RSP has gained 3.90%, versus a 4.63% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of Uncommon Wisdom Daily.
About the Author: Grant Wasylik
Grant Wasylik is an analyst and editor for Uncommon Wisdom Daily — a division of Weiss Research.
Before joining the investment newsletter business, Grant worked as a portfolio manager, lead research analyst and head trader for a billion-dollar wealth management firm for 10 years. He also spent a few years working in a specialized risk-trading department at Charles Schwab — where he was the first-ever, external hire into this elite department. In his first stint in the securities business (after passing Series 7, 64 and 24 exams), Grant ran a margin department and supervised a trade desk for a discount brokerage firm.
Prior to coming to Uncommon Wisdom Daily, Grant was co-editor and chief analyst of The Palm Beach Letter for two years. This monthly publication — with over 70,000 subscribers — focused on safe, income-oriented investments.
Due to his vast investment experience, Grant has a deep contact list comprised of 400-plus mutual fund, ETF, index, hedge fund and other top-notch financial professionals. In addition, he receives special invitations to — and attends — several of the world’s top investment conferences each year.