The S&P Is Being Upstaged By Its Little Brother, And It Has Been For The Last 20 Years

The S&P Is Being Upstaged By Its Little Brother, And It Has Been For The Last 20 Years
Andrew Rummer

over 2 years ago3 mins

  • While almost every investor is familiar with market-cap weighted indexes like the S&P 500, far fewer have heard of their equal-weighted siblings.

  • ETFs tracking these more obscure indexes offer a simple and cheap way to invest in the stock market while keeping a few giant firms from dominating your portfolio.

  • And, over the past two decades, the equal-weighted index of US stocks has soundly beaten the S&P 500 – climbing almost twice as much.

While almost every investor is familiar with market-cap weighted indexes like the S&P 500, far fewer have heard of their equal-weighted siblings.

ETFs tracking these more obscure indexes offer a simple and cheap way to invest in the stock market while keeping a few giant firms from dominating your portfolio.

And, over the past two decades, the equal-weighted index of US stocks has soundly beaten the S&P 500 – climbing almost twice as much.

Mentioned in story

You probably already know that the S&P 500 gives you broad exposure to the US stock market. But you might not know that the index has a much less famous sibling – one that’s generated almost double the returns over the past two decades. Allow us to introduce the S&P 500 Equal Weight Index (ticker: SPW).

🤔 What’s the difference between the two?

Stock market indexes – and the exchange-traded funds (ETFs) that track them – are unambiguously great. For a tiny fee, investors can spread money across hundreds of stocks and then sit back and forget about it as the index periodically rebalances to reflect the market. 

The S&P 500 is a market-cap weighted index, meaning it allocates funds to stocks in proportion to their size. In other words, the biggest stocks have the biggest weight in the index. The top five companies – Apple, Microsoft, Alphabet, Amazon, and Facebook – currently account for 21% of the overall index, leaving just 79% for the other 495.

The S&P 500’s top-weighted stocks
The S&P 500’s top-weighted stocks (Source: State Street)

But the Equal Weight Index (EWI) is split equally across its 500 constituents. Each company – no matter how huge – makes up just 0.2% of the index. 

That may seem like a minor tweak, but it’s created a huge difference in returns since the start of the current century. $100 invested into a fund tracking the S&P 500 on the last day of 1999 would be worth $287 today (excluding any fees). The same sum invested into the EWI would be worth $539 – 88% more.

Chart of the equal weight index versus the S&P 500
(Source: Bloomberg)

Investing in the EWI means you’re effectively buying the “average” US stock. And by tilting away from the biggest firms, funds tracking the EWI shovel more of your money to smaller companies, which tend to have more potential for future growth. Equal-weighting also gives better portfolio diversification: no one company can drag you down too much. 

⚾️ So what’s the catch?

Equal-weight indexes often miss out on the headiest market bubbles, when wave after wave of investor cash pours into the biggest winners. But to be fair to them, this is more a feature than a bug. 

Check out this chart, which divides the Equal Weight Index by the S&P 500: the line rises when the EWI is doing better and drops when the S&P 500 is doing better. The EWI rose less than the wider market in the late ‘90s as the internet bubble inflated, but also fell less when the bubble popped. It likewise underperformed the S&P 500 in the financial crisis of 2008 and the coronavirus panic of early 2020, when investors were fleeing to the relative safety of the biggest companies. 

(Source: Bloomberg)
Chart of the equal weight index divided by the S&P 500

The fees for equal-weight indexes can be higher too. The Invesco S&P 500 Equal Weight ETF (ticker: RSP) has an expense ratio of 0.2%, roughly double that of the S&P 500 ETF Trust (ticker: SPY). That isn’t particularly surprising, mind you: the more obscure the fund the higher the fees tend to be, as a rule. And besides, a 0.2% fee is hardly extortionate. 

📈 What’s the opportunity here?

If you’re tempted by the idea of equal-weighting, American investors should find Invesco’s RSP ETF (mentioned above) listed by their broker. Non-Americans, meanwhile, could check out the Xtrackers S&P 500 Equal Weight ETF (ticker XDEW). 

Flows into these ETFs suggest that investors are expecting a new period of outperformance for the equal-weight S&P 500: Invesco’s RSP fund has swelled by 37% since the start of the year, while the biggest ETFs following the S&P 500 have added just 3% of additional investor cash, according to Bloomberg. 

The trend doesn’t seem to be resonating with the Finimize community yet, mind you. Of the 82 Finimizers who submitted investment pitches in our June stock-picking contest, a dozen were tempted by S&P 500 trackers – but not one mentioned an equal-weighted measure.

Of course, there’s no guarantee that the EWI will beat the S&P 500. After all, it fared worse than the market in each of the last four full calendar years. But, over the longer term, history suggests that equal weighting is your friend. 

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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