SPY, RSP: Is the Equal Weight ETF Party Over?

Sometimes, you feel something as an investor, but you don’t have the evidence to back it up. As political comedian and TV host Bill Maher says, “I don’t know it for a fact, I just know it’s true.” 

Schwab's Liz Ann Sonders helped solve one current market mystery with a recent social media post that showed that the ratio of returns of the S&P 500’s equal weighted index to the market capitalization version of that same index surged during the fourth quarter.

But then, as has been the case for years, the latter, more popular version of the S&P 500 is rebounding from that temporary loss of dominance.

The easiest way for investors to compare the two S&P 500-based rivals is to use etf.com’s comparison tool for the SPDR S&P 500 ETF Trust (SPY) and the Invesco S&P 500 Equal Weight ETF (RSP). One look at their comparative asset totals tells us that money follows performance.

They have both been around for a long time, so even though SPY was the first-ever U.S.-listed ETF in 1993, RSP has had plenty of time to catch up.

But today, SPY stands at $490 billion. RSP, one of the largest ETFs around, is roughly one-tenth the size of SPY, at $49 billion.

SPY trades 30 times the average daily volume of RSP, and I’m willing to wager an iced tea with anyone that most investors don’t know how SPY is weighted, and that there even is an equal-weighted version.

Or if they do know that the index can be owned in the manner of what RSP represents, they probably assume that equal weighting is the only way ETF investing is done. Spoiler alert: it is not. 

A Weighty Issue for ETF investors

This is not at all a slight against investors. However, it is part of the tremendous educational effort that the ETF industry is actively pursuing. Because the lesson of past market crises is that too many investors thought they were diversified, only to find out that a small number of stocks drove their 401ks and private accounts up and then down. Equal weighting, by its nature, solves that risk, even if the broader risk of equity markets is still ever-present in any ETF that tracks an unhedged version of the stock market.

SPY’s 1-year return is 24.4% and RSP’s is only 8.1%. That’s the Magnificent Seven talking. And, while the 10-year annualized return comparison is tighter (SPY at 12.6%, and RSP at 10.5%), that’s a lot of return sacrificed. It is also the past, which we know does not guarantee anything about the future. Still, that trailing information, the popularity of cap-weighted ETF investing and the latest recent stumble (RSP up only 0.4% the past month versus SPY’s 3.3%) are another warning shot to ETF providers who wish to make the case for equal-weight investing.

Sector ETFs to Watch 

Finally, I did some data digging and found that at the sector level, the same observations ring true, at least about the past. Of the 11 S&P 500 sectors, nine have at least 10-year track records in ETF form for both styles of investing (REITs broke off from Financials, and the Communications sector was created, both within the past 10 years).

Of those nine, two sectors have a better 10-year equal weighted return than cap weighted. Those sectors, Industrials and Basic Materials have outperformed in equal weighted form over that time, by a couple of percentage points per year. Utilities was a slight outperformer in equal weight terms but not enough to emphasize. So, perhaps those two sectors can be considered differently by investors. 

It is a long uphill climb for equal weighted ETFs because first the performance must compensate for lost time and then investors’ recognition must follow. This should be a fascinating battle for industry participants to watch in the months and years ahead.