The equal-weight methodology is one of the oldest and most widely embraced smart beta strategies. In the world of exchange-traded funds (ETFs), the Guggenheim S&P 500 Equal Weight ETF (RSP) is the largest, with nearly $14.8 billion in assets under management. One way of viewing RSP's heft is that investors are comfortable applying the equal-weight strategy to large-cap stocks. The average market capitalization on the S&P 500's 505 components is north of $48 billion, which is deep into large-cap territory, further confirming the point that advisors and investors will embrace the combination of large stocks and equal weighting.
On a cap-weighted basis, the S&P MidCap 400 and the S&P SmallCap 600 indexes have historically outperformed the large-cap S&P 500. That fact could prompt some ETF users to ponder the efficacy of equal-weight strategies for mid- and small-cap stocks. The Guggenheim S&P MidCap 400 Equal Weight ETF (EWMC) and the Guggenheim S&P SmallCap 600 Equal Weight ETF (EWSC) are RSP's mid- and small-cap cousins. The mid-cap EWMC and the small-cap EWSC have less than $146 million in combined assets under management, indicating that investors are not yet widely embracing equal-weight strategies for smaller stocks on par with large-cap offerings. Perhaps they should. (See also: Inside Some Benefits of Equal-Weight ETFs.)
"Equally weighted indices have a smaller market capitalization mathematically so have outperformed the market cap weighted indices over the long term," said S&P Dow Jones Indices. "Simply, the S&P equally weighted indices for their respective sizes use the universe from the relevant market cap universe and allocate 100%/(n stocks) weight to each stock, then rebalance quarterly. For example, the S&P 500 Equal Weight Index rebalances quarterly to equal weight each stock in the S&P 500 at the company level of 1/500 = 0.02%."
Historical data suggest that equal-weight indexes for smaller stocks have outperformed their cap-weighted rivals. Over the past 10 years, the S&P MidCap 400 Equal Weight Index produced average annualized returns of 10.6% compared with 9.7% for its cap-weighted equivalent. The S&P SmallCap 600 Equal Weight Index generated average annualized returns of 11.2% compared with 10.5% for its cap-weighted rival, according to S&P data. (See also: What Is the Best ETF for Trading Mid-Cap Stocks?)
The current environment could be conducive to equal-weight strategies for smaller stocks. "In an environment where rising interest rates, accelerating growth, possibly rising inflation and a falling dollar are in place, it may help small and mid caps, especially in energy, financials, materials and information technology," said S&P Dow Jones. "The equally weighted indices may be a good choice for smaller-cap exposure without making a separate small-cap allocation." (For more, see: An Introduction to Small-Cap Stocks.)