The potency of equal weighting has been on display for several years in the exchange traded funds universe with equal-weight ETFs occupying a spot in the strategic beta group, one of the fastest-growing segments of the ETF industry.
As is the case with traditional ETFs, there are various ways to slice and dice equities with equal-weight ETFs. The ALPS Equal Sector Weight (EQL) is an example of a unique equal-weight ETF. EQL debuted in July 2009, making it an ETF of ETFs before that concept became popular. The almost $145 million EQL applies equal weighting to the nine sector SPDR ETFs from State Street Global Advisors. [An ETF for the Indecisive Sector Investor]
“Although equal weighting of sectors can result in faster or slower earnings growth versus the S&P500 in any single year, profitability is similar on average. However equal-weighting aims to systematically avoid the excesses of the cap-weighted benchmark (such as the Financial crisis and the Tech bubble before that) making it ideal for “set-it-and-forget-it” investors who prefer somewhat less volatile returns,” said AltaVista Research in a recent research note.
AltaVista has a neutral rating on EQL, which “indicates that valuations adequately reflect the fundamentals of stocks in these funds. The majority of funds we cover fall into this category.”
Weights for EQL’s range from 10.63% for the Energy Select Sector SPDR (XLE) to 11.33% for the Consumer Staples Select Sector SPDR (XLP) . Wide swings in sector performance can reduce diversification and increase volatility in a portfolio, according to ALPS.
Although one of the tenants equal weighting is the effort to avoid large allocations to overvalued stocks and sectors, a frequent criticism of cap-weighted ETFs, EQL’s three largest are the sector SPDR funds that track the three sectors that are currently the most richly valued relative to the S&P 500 – XLP, the Utilities Select Sector SPDR (XLU) and the Consumer Discretionary Select Sector SPDR (XLY) . [Sector ETFs Swell in Size]
Conversely, XLE, which tracks the sector currently most undervalued against the S&P 500, is EQL’s smallest holding. AltaVista has a bold overweight rating, the only one of the nine SPDRs the research firm currently applies that rating to.
“Profit expectations have been deteriorating rapidly as oil prices have fallen, and OPEC’s recent decision to maintain production levels is confirmation that larger supplies from America’s shale oil & gas revolution means lower energy prices–great for consumers but a threat to the long-term profitability of Energy firms. The Energy sector appears attractive in terms of valuation, but momentum isn’t currently in the sector’s favor,” said AltaVista.
EQL’s estimated 2015 P/E is 16.7 with a price-to-book ratio of 2.3, according to AltaVista data. The ETF charges 0.54 per year.
ALPS Equal Sector Weight ETF
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.