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Time for This Top-Ranked Equal-Weight ETF?

Zacks Equity Research

The bull run that the U.S. market enjoyed in the first half of the year is likely to continue on improving job and inflation data. The Debt ceiling and other D.C. issues may hold back the winning ways for a while.

Needless to say, all eyes were on QE “tapering” of late, but the speculation about partial trimming ended with a surprising decision by the Fed to continue with the $85-billion monthly bond-buying program until the economy gains more strength (see more in the Zacks ETF Center).

While on one hand, the news perked up the stock market, on the other, a modest downgrade to the Fed’s GDP outlook for this year and 2014 indicates that investing can be a bit risky in the near term, suggesting investors to tap any space with caution. It is worth noting that the degree of the index movement depends heavily on its weighting methodology.
For instance, a market capitalization weighted index is more susceptible to a decline in companies that are large caps than in companies with a higher fundamental weight such as revenues or earnings. Hence, while cap-weighted counterparts are certainly good options, a play that spreads out assets more could be warranted by looking at the often forgotten ‘Equal Weight ETFs’.
The best part of the equal-weight fund is that it keeps the portfolio free from concentration risk. Moreover, thanks to rebalancing every quarter, such funds easily get to avoid the overvalued segments and reinvest in those that are underperforming, thereby clinching potential gains in outperforming stocks.
Given this bullish trend, and the positive environment for smaller cap securities, a look at some of the top ranked ETFs in the space could be a good way to target the best of the segment. In order to do this, investors can look at the Zacks ETF Rank and find the top Equal-Weight ETF (Read: Overweight These Equal Weight ETFs in Your Portfolio).  

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box or asset class. Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of three risk ratings, namely Low, Medium or High.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of the five ranks within each risk bucket. Thus, the Zacks ETF Rank reflects the expected return of an ETF relative to other products with a similar level of risk.

For investors seeking to apply this methodology to their portfolio in the Equal-Weight space, we have taken a closer look at the top ranked RSP. This ETF has a Zacks ETF Rank of 1 or ‘Strong Buy’ (see the full list of top ranked ETFs) and is detailed below:

About RSP
Investors on the lookout for equal allocations in the S&P 500 index could find Guggenheim S&P 500 Equal Weight (RSP) – launched in April 2003 – an exciting pick. The fund tracks the S&P Equal Weight Index, not putting more than 0.29% of assets in a stock.
The fund has now amassed more than $5.0 billion in assets and trades in volumes of 800,000 a day on average. However, an expense ratio of 40 basis points is a potential drawback, especially when some of the other ETFs tracking the broader U.S. equity markets are much cheaper (read: Are Equal Weight ETFs Worth The Cost?).
This fund holds about 500 securities. Top companies include E*Trade Financial, Best Buy and Goodyear Tire, all of three account less than 0.5% of the total assets. The concentration level in the top 10 holdings is as low as 2.59%. This clearly signifies why the approach is not susceptible to the returns of a particular stock or group of securities.
In terms of industry breakdown, consumer discretionary, financials and information technology take the top three spots at about 47.0% of assets, followed by industrials (12.6%) and health care (10.9%) also receiving double-digit allocation.
Meanwhile, investors should note that the fund is skewed heavily toward cyclical sectors which can in turn raise its risk quotient. As such, we have a ‘High’ risk outlook for RSP in the near term. However, an almost sole focus on large caps provides some cushion on the risk profile since large cap funds are less volatile.
RSP has fetched about 20.5% in returns on a year-to-date basis, which is higher than SPDR S&P 500 ETF (SPY) by roughly 400 basis points over the same period (read: 6 ETFs Beating the Market Over the Past Year). Fortunately, historic trends also favor the ETF, as it has outgained SPY since inception, adding about 10.61% compared with a 8.56% return offered by the market cap weighted version (as of June 30, 2013). RSP also pays out a yield of 1.42% per annum.

The ETF currently has a Zacks ETF Rank of 1 or ‘Strong Buy’ with ‘High’ risk outlook, suggesting that it is positioned to outperform similar competitors in the future as well (read: Zacks ETF Rank Guide).
Bottom Line
The tilt towards consumer discretionary, financial and tech sector, all of which ended the 2Q earnings season on a decent to high note proclaiming a beat ratio of 50%, 76.9% and 66.7% respectively, suggests that further gains are possible in RSP. Stock-market performances for these sectors have also been overwhelming as of late.
While the picture is presently a bit dicey thanks to the unanticipated ‘Zero Taper’, analysts’ estimates for the ensuing quarters (Q4 and beyond) have shown increases. In fact, a lot of the Q4 growth is expected to come from sectors other than Finance – the 2Q topper.
The only one word of caution is that things may reverse sharply, if market dynamics change for some unforeseen reason as a downturn hits cyclical sectors the most. But either way, RSP looks to be a solid performer, and it is definitely worth a closer look by investors seeking a broad market play.
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