Using equal-weighted ETFs can help put a small-cap and value tilt on a portfolio.
This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Clayton Fresk, CFA, portfolio management analyst at Georgia-based Stadion Money Management.
Rick Ferri recently posted an article regarding portfolio tilting and the usage of small-cap and value ETFs. He described a process involving starting an allocation with total market-cap exposure and adding a slice of small-cap value stocks.
For advisors who have existing portfolios allocated toward a mix of different assets classes that may not easily afford switching to an allocation as Ferri described, an alternative way to capture the small/value tilt is through using equal-weighted as opposed to market-cap-weighted ETFs in various asset classes.
I’ll look at a variety of the different equal-weighted ETFs available and how substituting them into an existing portfolio may positively alter the risk/return profile of a portfolio.
The number of equal-weight ETFs and asset classes covered has increased over the past few years. Here is a list of equal-weight ETFs available:
|Ticker||Fund||AUM ($M)||Exp Ratio|
|Large Cap||RSP US||Guggenheim EW S&P 500||8372.2||0.40%|
|EWRI US||Guggenheim EW Russell 1000||115.5||0.40%|
|Mid Cap||EWRM US||Guggenheim EW Russell Midcap||138.3||0.41%|
|Small Cap||EWRS US||Guggenheim EW Russell 2000||40.6||0.41%|
|Nasdaq||QQEW US||First Trust EW Nasdaq 100||428.2||0.60%|
|QQQE US||Direxion EW Nasdaq 100||14.6||0.35%|
|EM||EWEM US||Guggenheim EW MSCI Emerging Markets||14.4||0.60%|
|Sector||RCD US||Guggenheim EW S&P Consumer Discretionary||88.9||0.50%|
|RHS US||Guggenheim EW S&P Consumer Staples||160.4||0.50%|
|RYE US||Guggenheim EW S&P Energy||308.1||0.50%|
|RYF US||Guggenheim EW S&P Financials||100.8||0.50%|
|RYH US||Guggenheim EW S&P Healthcare||224.4||0.50%|
|RGI US||Guggenheim EW S&P Industrials||103.8||0.50%|
|RTM US||Guggenheim EW S&P Materials||90.1||0.50%|
|RYT US||Guggenheim EW S&P Technology||579.8||0.50%|
|RYU US||Guggenheim EW S&P Utility||120.1||0.50%|
|MLP||MLPN US||Credit Suisse EW MLP||926.6||0.85%|
A few other equal-weight ETFs of note, particularly in the large-cap space:
- ALPS Equal Weight ETF (EQL): Holds equal weights in the nine SPDR Sector ETFs
- VelocityShares Equal Risk Weighted Large Cap ETF (ERW | C-72): Applies a proprietary risk weighting to the S&P 500 stocks and equal-weights accordingly
Also, the equal-weighted Russell 1000, midcap and 2000 ETFs named above have two layers of equal weighting. First, each sector is equally weighted, and then within the sector, each individual stock is equally weighted.
By taking out the cap-weighting aspect, the equal-weighted ETFs will naturally have smaller-cap skews.
As noted, this is one mechanism an advisor can use to gain a smaller-cap tilt without altering an existing asset class allocation. The degree of the tilt can vary depending on the market-cap segment. I will focus on the large-, mid- and small-cap names from above.
|Equal Weight S&P 500||37.50||96.4||3.6||-||31.3||68.7|
|Market Cap S&P 500||128.30||99.5||0.5||-||52.2||47.8|
|Equal Weight Russell 1000||22.99||72.9||26.8||37.1||62.9|
|Market Cap Russell 1000||113.37||94.8||5.0||52.7||47.3|
|Equal Weight Russell Midcap||8.60||66.2||33.4||-||45.3||54.7|
|Market Cap Russell Midcap||11.98||86.5||16.2||-||49.5||50.5|
|Equal Weight Russell 2000||1.12||-||16.8||82.8||45.0||55.0|
|Market Cap Russell 2000||1.74||-||38.2||61.7||50.2||49.8|
Because the range of market caps defining the large-cap universe is much broader than that of mid- and small-cap universe, equal weighting in large-caps will have a more dramatic effect. Stated differently, the difference in size between the largest and smallest large-cap name will be much wider than the difference in size between the largest and smallest small-cap name.
This effect can be seen in both the market-cap differential as well as the style analysis. Focusing on the equal- versus cap-weighted Russell 1000 from above, the market-cap difference is nearly $90 million. The equal weight also has a larger skew toward the midcap exposure than the market-cap-weighted.
Looking at the style analysis, the equal weight has a nearly two-thirds value and one-third growth split versus the market-cap-weighted—nearly 50/50.
To analyze the effect using equal-weight ETFs may have on a portfolio, I will use the following hypothetical portfolios:
|Index (Bloomberg Ticker)||Portfolio A||Portfolio B|
|Market Cap Large 1||SPXT||25||20|
|Equal Weight Large 1||SPXEWTR||0||5|
|Market Cap Large 2||RU10INTR||25||20|
|Equal Weight Large 2||RU1ELCTR||0||5|
|Market Cap Mid||RUMCINTR||15||10|
|Equal Weight Mid||RUMEMCTR||0||5|
|Market Cap Small||RU20INTR||15||15|
|Market Cap EM||NDUEEGF||10||5|
|Equal Weight EM||M1EFEWGT||0||5|
|Market Cap MLP||AMZX||10||5|
|Equal Weight MLP||MLPXTR||0||5|
Because many of the ETFs were brought to market at the end of 2010, I’ll use the appropriate index’s monthly total return—net of the fund expense ratio—to get a longer-dated analysis. Because of a lack of historical data, I’ll only use the market-weighted small-cap exposure in this analysis.
The results are as follows:
|Portfolio A||Portfolio B|
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.
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.
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.