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How Equal-Weight ETFs Can Protect a Portfolio

tlydon@globaltrend.com (Tom Lydon)

As the tech stock Apple (NasdaqGS: AAPL - News) has passed the $600 billion market capitalization threshold, some investors may be questioning the vulnerability of the recent performance. Exchange traded funds taking on an equal-weight indexing approach could be an answer for those questioning the effect that a falling Apple could have upon the broad market.

“We have a number of rules to avoid value traps. Among the most important are to not buy companies that are reporting losses and to have a large number of stocks in a portfolio that are equally weighted, to take the sting out of a devastating earnings surprise or other setback for any one company. I recommend equal-weighting of a large portfolio–at least 100 stocks and possibly more. Such portfolios over time have significantly outperformed the market,” Adam Zoll, assistant editor for Morningstar wrote in a recent article. [ETF Spotlight: Equal Weight S&P 500]

Shares of Apple have risen about 50% year-to-date, which in turn,  has lifted the S&P 500 Index about 9%. Investors may be questioning the outsized affect that falling shares of Apple would have upon the broad market. [ETF Chart of the Day: Technology Sector]

Sam Stovall, chief equity strategist for S&P Capital IQ, reports that there is a way to stay neutral to market events such as the aforementioned. An equal-weighted index can “level the paying field by removing the skewing effects of mega-cap stocks.”

ETFs have allowed investors to construct portfolios of equal weighted indices with a domestic or global approach. Moreover, some of the indices are concentrated in a certain asset class, allowing targeted diversification.

An equal-weighted index is an alternative to the common market capitalization index. Rather than tilting the index toward the largest companies, an equal-weight index assigns the same weighting to every stock represented. For example, the S&P 500 gives a 0.2% weight to each of the 500 components, and rebalances quarterly to adjust for changes in market values.

An equal weight index is known to perform better when the market favors small or mid-cap stocks. An equal weight index also avoids excessive valuations, when the market is driven by momentum, reports Investopedia. [Diversifying Away From Apple with Equal-Weight ETFs]

“On April 9 AAPL shares peaked at a 57% year-to-date advance, taking the S&P 500 along for a ride to a near 13% YTD gain. Since then, Apple shares declined nearly 5%, as did the overall market. During this outsized advance, investors have become increasingly vocal as to their concerns surrounding the influence that AAPL and the other mega-caps have on the performance of the overall index,” Sam Stovall wrote in a recent global equity research report. [Apple: Why the Nasdaq-100 ETF is Beating the Market]

Equal-weight ETFs:

  • Guggenheim S&P Equal Weight ETF (NYSEArca: RSP - News)
  • Guggenheim S&P Equal Weight Technology ETF (NYSEArca: RYT - News)
  • First Trust NASDAQ-100 Equal Weighted Index Fund ETF (NYSEArca: QQEW - News)

Tisha Guerrero contributed to this article.