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Equal-Weight Indexing Has Been a Better Long-Term ETF Play

This article was originally published on ETFTrends.com.

The biggest ETFs have been getting all the attention over the years as investors grouped into these traditional market capitalization-weighted plays, but the ones tracking an equal-weight indexing methodology have been quietly outperforming all along.

The biggest and most popular ETFs on the market largely include those that track traditional market capitalization-weighting methodologies, or they weight component stocks based on the companies' market capitalization, so bigger companies have a greater say in the direction of the overall ETF's performance.

In contrast, an equal-weighted indexing, like its naming suggests, would equally distribute the weight among all company holdings within the index, regardless of the market cap of each company.

Pablo Fernandez, a finance professor at the University of Navarra, pointed out that by treating all companies equally in terms of how they can influence the whole group, the equal-weighted indexing methodology has provided a better return to investors over the past two decades, CNBC reports.

Researchers found that if an investor put $100 in the S&P 500 in January 2000, his or her investment would have grown to $252.60 in April 2018. In comparison, only $2.50 invested unweighted in the largest 40 companies taken from the S&P 1500 would have grown to $273.10 in April 2018. The research also shows that if one only invested $5 unweighted in each of the 20 smallest companies in the S&P 1500 in January 2000, the investment would be now worth at least $36,000.

Unweighted Indexes Vs Weighted Indexes

“We document that unweighted indexes have outperformed weighted indexes and that the S&P 400 and the S&P 600 have outperformed the S&P 500," the University of Navarra researchers said in a note, referring to the S&P 400 that tracks midcaps and the S&P 600 that tracks small caps.

For example, the Invesco S&P500 Equal Weight ETF (RSP) has generated an average annualized return of 10.5% over the past 15-years, whereas the SPDR S&P 500 ETF (SPY) generated an average annualized 9.2% return.

Due to the equal-weighting indexing methodology, smaller companies have a larger say in the direction of the fund's portfolio, compared to traditional market capitalization-weighted indexing methodologies. RSP shows a 14.1% tilt toward mega-caps, 49.0% large-caps and 36.9% mid-caps. In contrast, SPY holds 57.1% mega-caps, 34.3% large-caps and 8.6% mid-caps.

For more information on the equal-weight indexing methodology, visit our equal-weight ETFs category.