Small Cap Tilts With Equal Weight ETFs

July 24, 2014

Comparative_Portfolio_Returns

 

Portfolio A Portfolio B
Return 7.5% 8.5%
St Dev 15.9% 16.1%
Sharpe 0.35 0.40
Max DD -50.9% -50.8%
Avg DD -9.6% -8.6%
Exp Ratio 0.27% 0.30%

The addition of the equal-weighted exposure added nearly a 1 percentage point return per year with only moderately higher risk. Additionally, while the max drawdown for both portfolios was the same, the average drawdown for Portfolio B was nearly 1 percentage point better, meaning the portfolio recovered from its drawdown more rapidly.

Implementation

One aspect the analysis above ignores is the implementation of the strategy via ETFs—notably costs, tracking error, etc.

Currently, some of the equal-weighted ETFs mentioned are rather small and have low trading volumes. However, the liquidity of the underlying holdings looks to be much better than the ETF itself. For example, the 30-day average volume on EWRS is currently 5,700 shares.

However, the implied liquidity is nearly 267,000 shares. So, if one is looking to add these names into a portfolio, particularly in larger size, it may be important to consult an authorized participant to find the best way to implement the desired trade.

Conclusion

As Rick Ferri described in his article, the addition of small-cap and value stocks can have a positive benefit to a portfolio. After analyzing the use of equal-weighted ETFs, the addition of this exposure into an existing cap-weighted allocation could also provide positive risk/return benefits.


At the time this article was published, the author's firm held positions in RSP, QQEW and QQQE on behalf of clients.

Founded in 1993, Stadion Money Management is a privately owned money management firm based near Athens, Ga. Via its unique approach and suite of nontraditional strategies with a defensive bias, Stadion seeks to help investors—through advisors or retirement plans—protect and grow their “serious money.” Contact Stadion at 800-222-636 or www.stadionmoney.com. References to specific securities or market indexes are not intended as specific investment advice.

 

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