Wall Street staged a solid comeback in October, with all three major indices logging positive returns. The Dow Jones Industrial Average wrapped up its best month since 1976, surging about 14% in October, while the S&P 500 and the tech-heavy Nasdaq Composite Index gained about 8% and 3.9%, respectively. However, the rally fizzled to start this month on recession fears (read: Dow Jones Logs Best Month Since 1976: ETFs to Bet On).
Against this backdrop, equal-weighted ETFs are outperforming their market-cap counterparts. This is especially true as Invesco S&P 500 Equal Weight ETF RSP, Invesco S&P MidCap 400 Equal Weight ETF EWMC and Invesco S&P SmallCap 600 Equal Weight ETF EWSC gained 7.2%, 8.8% and 10.7%, respectively, over the past month. In comparison, cap-weight ETFs — SPDR S&P 500 ETF SPY, SPDR S&P MidCap 400 ETF MDY and SPDR S&P 600 Small Cap Growth ETF SLYG are up 4.9%, 7.7% and 6.3%, respectively.
Investors are betting that traditional stocks like banks will lead the next bull market. As banks seek to borrow money at short-term rates and lend at long-term rates, the rise in interest rates will help them earn more on lending and pay less on deposits, leading to a wider spread. This will expand net margins and increase banks’ profits.
Additionally, the U.S. economy posted its first period of growth in the third quarter. GDP grew 2.6% annually versus the estimate of 2.3%. A narrowing trade deficit as well as increases in consumer spending and government outlays boosted the growth.
However, the Fed’s aggressive tightening policy heightened the risk of a recession. The Federal Reserve raised interest rates by 75 bps for the fourth consecutive time. This is the sixth rate hike this year, a streak that has made mortgages and other consumer and business loans increasingly expensive (read: 5 ETFs Set to Benefit From Higher Rates).
The war in Ukraine, lockdowns in China, supply-chain disruptions, and tightening policy across the globe may continue to hurt growth.
Reasons for Outperformance
Equal-weight ETFs do a great job in managing single-security risk, thanks to their equal allocation in the entire spectrum of market capitalization levels regardless of size. As such, these limit the risk of a severe downfall in any particular security, providing a nice balance in the portfolio. Additionally, with quarterly rebalancing, equally-weight funds tend to cash in on the overvalued segments and reinvest in the underperforming ones, potentially allowing for outperformance if the trends reverse.
Overall, these funds not only go a long way in reducing overall risk but also provide higher diversification and higher returns over the long term when compared to the market-cap counterparts. Further, these offer more upside potential due to higher concentration in small and mid-cap stocks as compared to cap-weighted funds. These have a minimal concentration risk but charge a hefty expense ratio compared to the fundamentally/capitalization-weighted counterpart.
Equal-Weight ETFs in Focus
Invesco S&P 500 Equal Weight ETF (RSP)
Invesco S&P 500 Equal Weight ETF tracks the S&P 500 Equal Weight Index, which equally weighs stocks on the S&P 500 Index. It charges 20 bps in annual fees and has amassed $31.2 billion in its asset base. Invesco S&P 500 Equal Weight ETF trades in an average daily volume of 2.6 million shares and has a Zacks Rank #3 (Hold).
Invesco S&P MidCap 400 Equal Weight ETF (EWMC)
Invesco S&P MidCap 400 Equal Weight ETF tracks the S&P MidCap 400 Equal Weight Index, which equally weights mid-cap securities in the S&P MidCap 400 Index. It has AUM of $145.3 million and charges 40 bps in annual fees. Invesco S&P MidCap 400 Equal Weight ETF trades in an average daily volume of 4,000 shares and has a Zacks Rank #3 (read: Top-Ranked ETFs That Beat the Market in October).
Invesco S&P SmallCap 600 Equal Weight ETF (EWSC)
With AUM of $50.3 million, Invesco S&P SmallCap 600 Equal Weight ETF follows the S&P SmallCap 600 Equal Weight Index, which equally weights small-cap securities in the S&P SmallCap 600 Index. It charges 40 bps in annual fees and trades in an average daily volume of 3,000 shares. Invesco S&P SmallCap 600 Equal Weight ETF has a Zacks Rank #3.
Bottom Line
These equal-weight ETFs are relatively less popular, thereby leading to lower average daily volumes and a wide bid/ask spread compared to market-cap cousins. This increases the total cost of trading beyond the expense ratio.
Though these ETFs have a higher expense ratio and low trading volume, these do not seem to be big problems as the products avoid company-specific risks and enjoy diversification benefits.
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SPDR S&P 500 ETF (SPY): ETF Research Reports
Invesco S&P 500 Equal Weight ETF (RSP): ETF Research Reports
SPDR S&P MidCap 400 ETF (MDY): ETF Research Reports
Invesco S&P SmallCap 600 Equal Weight ETF (EWSC): ETF Research Reports
Invesco S&P MidCap 400 Equal Weight ETF (EWMC): ETF Research Reports
SPDR S&P 600 Small Cap Growth ETF (SLYG): ETF Research Reports
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Zacks Investment Research
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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