Investors looking for diversification in their portfolio might want to consider equal-weight sector exchange-traded funds, which are a savvy way for investors to spread single-stock risk and provide full sector exposure to the market.
Capitalizing on the idea, Rydex Investments of Rockville, Md., last week launched nine equal-weight sector ETFs based on Standard & Poor's equal-weight sector indices.
The funds, which trade on the American Stock Exchange, center around areas including consumer discretionary spending, consumer staples, energy, financials, healthcare, industrials, materials, technology and utilities.
"We wanted to do something innovative and beneficial and also reduce single stock risk," said Steve Sachs, director of trading at Rydex. He pointed out that this strategy has been used by institutions for a long time. The nine new ETFs expand Rydex's product line to 24, with the firm's ETF assets approaching $3 billion.
Three years ago, Rydex launched 11 equal-weight ETFs, and the firm has seen success in the area since then. As of September, the funds have attracted more than $1.6 billion in assets and have delivered an average return of 19.15% since their inception versus 12.81% for the S&P 500.
Unlike capitalization-weighted funds, which give the largest cap stocks the most influence within an index, Rydex's new funds will divide all stocks equally regardless of market capitalization in an attempt to give more accurate representation of a given sector.
"The equal-weight sector ETF's don't let investors get sucked in with market bubbles," said Marvin Appel, CEO of Appel Asset Management, an investment advisory firm in Great Neck, N.Y.
The equal representation across all stocks within a sector improves the chance for outperformance and helps avoid overexposure, according to Rydex. For example, in the consumer staples sector, Procter & Gamble represents 17.31% of its relevant index versus just 2.59% in the equal-weight version, which mitigates the dominance of a few large stocks.
Thus, Rydex's equal-weight ETFs aim to provide better returns for investors. "The equally weighted indexes normally outperform their cap-weighted counterparts," said Carl Swenlin, president of DecisionPoint.com of Redlands, Calif., a technical analysis website.
Equally weighted products tend to favor small-cap and value stocks, which right now are performing favorably in the market, but large-cap growth funds might be poised for a comeback, experts noted. Should small- and mid-cap stocks get hammered, that would be bad for Rydex's equal-weight ETFs, experts noted.
The equal-weight sector ETFs must rebalance quarterly to maintain an equal-weight stance, which may promote greater internal diversification and a relatively higher exposure to value stocks. The downside to this is that investors may incur higher transaction costs for these types of funds because all the stocks have to be rebalanced to the same weight again, which involves more trading, experts noted.
However, "in the past people have thought that the rebalancing costs will kill you, and while rebalancing cost is not free, it doesn't kill you," commented David Blitzer, S&P's managing director and chairman of the index committee.
Explaining the equal-weight sector ETFs to clients can be easier than explaining cap-weighted ETFs and index funds, said Tim Meyer, ETF business manager at Rydex. But as a whole, the industry is doing a good job of educating consumers about ETFs, he added.
But while the popularity of ETFs has risen markedly in the past few years, not everyone is so certain investors and advisers will embrace Rydex's equal-weight ETFs. "Some financial advisers are waiting to see if this is a flash in the pan, or if these products are representative of an evolution, particularly within the structure of ETFs," said Jeff Tjornehoj, a senior research analyst with Lipper of New York.
Nonetheless, other index providers and investment firms have taken to the idea of equal-weight ETFs, as well. Nasdaq and First Trust Advisors teamed up earlier this year to launch exchange-traded funds tied to the performance of Nasdaq equal-weight indexes. The First Trust Nasdaq-100 Equal Weighted Index Fund tracks the Nasdaq Equal Weighted Index, which includes the 100 largest non-financial securities listed with Nasdaq.
Also, State Street Global Advisors offers three ETFs based on the equal-weighted S&P Select Industry Indexes.
"Without much effort, equally weighted ETFs are a creative way for people to invest and a way to keep investing simple, which is a key part of this whole message," Blitzer said.
"The S&P Equal Weight Sector Indices combine an equal-weighted methodology, preferred by some investors, with the familiarity of the S&P 500 universe," added Robert Shakoto, managing director at S&P Index Services.
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