I found a little report on the equal weighted S&P 500 Index “Are equal weighted indexes better than market cap weighted indexes?” It summarizes what we knew already, that the S&P 500 Equal Weight Index holds more of more of the smaller large-caps and less of the large large-caps and so its superior performance of late can be attributed to the better recent performance of the mid-caps over large-caps:
There is nothing wrong with the S&P 500 Index – it is a well-constructed and maintained passive benchmark. For those who do not like market capitalization-weighted indexes,
the S&P 500 Equal Weight Index is an alternative. But as I have shown in Figure 1 through Figure 4, the S&P 500 Equal Weight Index behaves more like value and mid to small-cap indexes . . . Thus, if one wants to get the exposure to the factors that influence the S&P 500 Equal Weight Index, then they probably could combine a group of passive market capitalization-weighted indexes to produce a similar pattern of returns. Given the cost of replicating an equal weighted index (brokerage costs associated with periodic rebalancing), it would seem investors could do better over the long term by using a combination of lower cost, lower maintenance, market capitalization weighted index funds as opposed to an equally-weighted index fund to gain the portfolio sensitivities desired.
He is correct in that there are higher costs associated with an equal weight index. The rebalancing bonus is small but it might cancel out or even trump the effect of the slightly larger MER on the ETF that matches the S&P 500 Equal-Weight Index, the Rydex S&P Equal Weight ETF (RSP).
I’d also expect an equal weighted index to have higher volatility than a market weighted index, as small and mid-sized companies tend to have more volatile earnings than larger companies.
So, if you look at risk-adjusted return, the equal weighted index may underperform the market weighted index after allowing for rebalancing costs (I just guessing, as I don’t have any data to back this up).
Regards
http://enoughwealth.com
You could be right, the risk-adjusted return might be the same or worse in the equal-weighted one. I don’t see much greater risk in the smaller companies in the S&P as they are still above $2 billion in market cap which is pretty big.