Equal weight investing has become increasingly popular in recent years. It refers to assigning equal weights to each constituent stock in an index or portfolio, rather than weighting the stocks based on their market capitalization. This method can provide significant diversification benefits and reduces concentration risk compared to market cap weighted indexes like the S&P 500. In this article, we will analyze some real-world examples of equal weight strategies applied to S&P 500 stocks and evaluate their advantages.
RSP Equal Weight ETF outperforms market cap weighted S&P 500
The Invesco S&P 500 Equal Weight ETF (RSP) is one of the most prominent equal weight S&P 500 ETFs. RSP equally weights all 500 stocks in the S&P 500 index and rebalances quarterly. From its inception in 2003 through 2021, RSP has delivered an annualized return of 11.57%, outperforming the market cap weighted S&P 500’s 10.66% return over the same period. This demonstrates the power of avoiding concentration risk and allowing smaller companies to contribute more to performance.
Sector bets are neutralized for diversification
In a market cap weighted S&P 500 index, certain sectors like technology and healthcare can grow to dominate based on past performance. RSP’s equal weighting approach helps neutralize these sector bets – no sector makes up more than 20% of the portfolio. This prevents overconcentration while allowing investors to maintain broad market exposure.
Top holdings are more diversified
The top 10 holdings in S&P 500 account for over 25% of the portfolio. But in RSP, equal weighting brings the top 10 down to just 2.8% of assets. This significant reduction in concentration risk improves diversification and stability of returns.
Rebalancing provides buy low, sell high opportunities
RSP rebalances quarterly to maintain equal stock weights. This results in buying underperformers at lower valuations and trimming recent winners. Over time, this buy low sell high dynamic has added to outperformance compared to a static market cap weighted index.
In conclusion, equal weight investing strategies applied to S&P 500 stocks have demonstrated meaningful diversification benefits and outperformance historically. Avoiding concentration risk in mega cap companies and allowing smaller stocks to contribute more to returns have been key performance drivers. For investors seeking broad index exposure with better risk-adjusted returns, equal weight S&P 500 ETFs present an compelling option.