Equal-weighted ETFs mark five-year anniversary

Introduced five years ago, the Rydex S&P Equal Weight Exchange Traded Fund opened the gates to investments pegged to indexes that use some measure other than market capitalization to determine company weightings. At the end of last year there were at least 67 ETFs pegged to so-called alternative indexes, with assets of just over $7 billion, according to Morningstar Inc. of Chicago. In opening the floodgates to such ETFs, however, Rydex Investments of Rockville, Md., also stirred a debate on whether weighting an index that relies on anything other than market cap is really an actively managed investment. That debate still rages, making it challenge for Rydex to market an ETF lineup that now consists of 10 equal-weighted ETFs. But Rydex is using the five-year anniversary of its first equal-weighted ETF to cut through the noise. It's focusing on the ETF's five-year track record to prove that investments that follow an equal-weighted index are a valuable complement to traditional cap-weighted investments. It's a tricky argument based just on the numbers.

A NUMBERS GAME

While it's true the $1.3 billion Rydex S&P Equal Weight ETF had a five-year annualized return though the end of March of 12.56%, and the cap-weighted Standard & Poor's 500 stock index had a return of 9.84%, the fund's short-term record was not as rosy. Through the end of March, the fund had a three-year annualized return of 5.29%, compared with the S&P's return of 5.85%, and a one-year return of -10.55%, compared with -5.08%. Year-to-date through the end of March, the ETF was down 8.91%, beating the S&P 500 index, which was down 9.44%. "Although equal weighting tends to outperform over time, there are periods when a cap-weighted ap-proach will do better, depending on market conditions," said Ed Lopez, director of ETF strategies at Rydex. "This underscores the complementary nature of a combined cap-weight/equal weight approach to investing." The Rydex S&P Equal Weight ETF provides broad market exposure by tracking the S&P Equal Weight Index, which includes the same 500 stocks as the S&P 500. But unlike the S&P 500, which is weighted by market cap, the S&P Equal Weight Index assigns an equal weight to each of the 500 stocks, eliminating the bias toward large-cap companies. "From a diversification standpoint, equal weighting offers investors inherent rebalancing of gains, as well as increased exposure to smaller, more nimble stocks within the S&P 500," Mr. Lopez said. "We've seen financial professionals take advantage of [the Rydex S&P Equal Weight ETF's] equal-weight methodology to help reduce single-stock risk and better diversify predominantly cap-weighted portfolios." Since the advent of equal weighting, many advisers are looking at their allocations and coming to the conclusion that it's prudent to use equal-weighted ETFs, said Tom Lydon, president of Global Trends Investments, a Newport Beach, Calif.-based firm that manages $75 million in assets. "I think for the lion's share of advisers, it would be an excellent core holding," said Mr. Lydon, who is also a director at Rydex.

WHAT'S THE POINT?

But not all advisers agree. "I haven't used any of the equal-weighted ETFs," said Richard Romey, president of ETF Portfolio Solutions Inc., an Overland Park, Kan.-based adviser with $40 million under management. That's because the S&P 500 has a much longer real-world track record and it's what the investing public knows and understands, he said. "Everyone is trying to create the better mousetrap when I feel we already have the best mousetrap for what we are trying to do," Mr. Romey said. Such opinions, however, are unlikely to dissuade Rydex from coming out with more equal weight ETFs. Standard & Poor's is working to create an international equal weighted index version of the S&P 700 international stock index, said Srikant Dash, head of global re-search and design at Standard & Poor's Index Services of New York. There would be "strong interest" in an ETF based on such an index, said Tim Meyer, ETF business manager for Rydex. He declined, however, to say whether such an ETF was in the works. E-mail David Hoffman at dhoffman@investmentnews.com.