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Why Equal Weighted Mutual Funds Scoring Over Index Funds

Zacks Equity Research

Index funds that invest in different small, mid and large-cap companies in the same proportion are specifically known as equal-weight index funds. Investing in equal-weight funds helps in reducing single stock risk and simultaneously generates attractive returns. Investors interested in maintaining a diversified portfolio might consider investing in equal-weight funds.

Not Overly Dependent on Large Caps

Index funds saw strong investments in 2016. According to The Wall Street Journal, index funds attracted a record $400 billion-plus investment last year. However, index funds invest heavily in large-cap companies, following which investors are more susceptible to individual company risk.

Also, significant exposure to mid and small-cap issuers might benefit investors of equal-weight mutual funds as these companies have the scope to outperform their large-cap counterparts in the long run. This is mostly because unlike mega-giant and large companies, mid and small caps have enough room to grow in the market. Also, any uncertainty in global markets will affect the behemoths first, while mid and small-cap companies will remain unfazed with more domestic exposure.

Mid-cap companies, with market capitalization between $2 billion and $10 billion, have a higher growth potential than the large-cap ones, while small-cap companies, which have market cap of less than $2 billion, offer strong returns.

In this respect, investors should look beyond index funds and focus on equal-weight mutual funds as these provide better and diversified market exposure to investors.

For example, mutual funds like Vanguard 500 Index VFINX and Schwab S&P 500 Index SWPPX invest in large-cap companies that fall within the range of the S&P 500 Index. The top three holdings of both VFINX and SWPPX are blue-chip companies, Apple Inc AAPL, Microsoft Corp MSFT and Exxon Mobil Corp XOM. Given below is the percentage distribution of assets of the two index-based funds in the three Dow components.

Fund Name

Apple

Microsoft

Exxon Mobil

Vanguard 500 Index

3.57%

2.43%

1.65%

Schwab S&P 500 Index

3.17%

2.47%

1.92%

On the other hand, equal-weight fund, Invesco Equally-Weight S&P 500 Fund Class R VADRX invested all its assets in equal proportions in equity securities of more than 505 companies. Further, as of the last filing, VADRX’s top three holdings were NVIDIA Corp NVDA, Allergan PLC AGN and Eli Lilly and Co LLY. The percentage portfolio weight in all the companies ranging from large-cap companies to small-cap entities generally stays near 0.20%. This makes an equal-weight mutual fund a strong investment option because of its ability to diversify its investments in each company equally and offer a strong stock market exposure.

Sector Distribution More or Less Even

For the last one year, equal-weight mutual funds garnered attention after the major equal-weight index outperformed the broader market. The S&P 500 Equal Weight Index returned 16.7% in the last one year, better than the benchmark index S&P 500’s one-year annualized return of 16%.

An equal-weight fund is a good choice for investors seeking diversification across sectors and companies, and focusing on gaining exposure to stocks that offer high level of returns. Investors with a strong risk appetite should pick these funds. In comparison to capital-weight funds that invest mainly in large-cap companies, equal-weight funds focus more on small and mid-cap companies. While, capital-weight funds invest around 45% of its assets in large-cap companies, equal-weight funds invest only 12% of its assets. This clearly indicates that an equal-weight fund is less dependent on the top 25 companies on the S&P 500 index and has a well-diversified portfolio.

Moreover, it can be seen that index fund have invested around 18% of its assets in the tech sector. Also, the top two holdings, Apple and Microsoft, in index funds are from the tech sector. In contrast to this, equal-weight funds have invested in the key S&P 500 sectors, with only 12% of its assets in the tech sector. For example, Vanguard 500 Index invested more than 35% of its assets in the technology and financial services sectors, whereas a major equal-weight fund, Index Funds S&P 500 Equal Weight No Load Shares INDEX, invested its assets in various cyclical, sensitive and defensive sectors. Less exposure in any particular sector helps INDEX to overcome any sudden market uncertainty.

 

Fund Name

Sectors

VFINX

INDEX

Technology

19.25%

11.84%

Financial Services

16.46%

13.64%

Healthcare

14.39%

12.21%

Consumer Cyclical

10.84%

15.47%

Industrials

10.49%

14.10%

Consumer Defensive

9.53%

8.31%

Energy

6.63%

7.10%

Communication Services

4.05%

1.85%

Utilities

3.19%

5.81%

Basic Materials

2.89%

4.51%

Real Estate

2.28%

5.16%

 

Conclusion

Equal-weight mutual funds are the need of the hour. And why not? Unlike index funds that are biased toward large caps and specific sectors, these types of funds minimize their risks by evenly distributing their weight across all caps, including medium and small-sized companies. Such funds also stay invested across all sectors in a more-or-less equal proportion. Needless to say, at a time of heightened uncertainly relating to whether Trump’s pro-growth policies will get implemented or not, equal-weight mutual funds have an undue advantage over their peers.

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