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What Lies Ahead for Equal Weight Funds After Trump Bump?
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Equal weight ETFs, one of the most easy-to-understand forms of ETF investing, do a great job in managing concentration risk, as these allocate an equal percentage of assets to all holdings. This therefore limits the probability of a severe drawdown in assets because of an adverse move in a single security.
The funds are diversified across a range of market caps and lock in gains of short-term winners and buy securities of the losers. However, this exposes investors to short-term volatility because of increased allocation to small cap stocks. Moreover, periodic rebalancing leads to higher transaction costs.
The markets have been surging since Trump was elected on November 8, 2016, mainly due to his promise of tax cuts and reduced regulations on banks. His pro-business outlook had a major impact on the financial markets. However, the Republicans faced a major setback recently.
The first major legislation passed by President Trump, the healthcare bill, was withdrawn on Friday, March 24, 2017. This resulted in reduced confidence among investors regarding the President’s ability to fulfill his other campaign promises, namely tax cuts and review of the Dodd Frank Act (read: Trumpcare Collapse Fuels Rally in Healthcare Stocks & ETFs).
The primary reason that equal weight ETFs outperform their cap-weighted counterparts is their methodology to assign the same weight to stocks across different levels of market capitalization. A large cap stock is assigned the same importance as a mid- or small-cap stock. In domestic bull markets, small-cap stocks outperform their larger-cap counterparts. This is because their major dealings are domestic, as compared to a high international exposure of mid cap and large cap stocks (read: Why Do Equal Weight ETFs Outperform?).
We will now look at the characteristics of the most popular equal weight ETF, RSP.
This fund is the most popular ETF in the equal weight space. It tracks the S&P 500 Equal-Weight index.
The fund has AUM of $13.1 billion and charges a fee of 40 basis points a year. Consumer Discretionary, Industrials, and Information Technology are the top three sectors from a holdings perspective with 16.4%, 13.5%, and 13.3% allocation, respectively. The fund returned 15.5% in the past year and 4.7% in the year-to-date time frame (as of March 29, 2017). RSP currently has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.
There are other sector specific equal weight ETFs such as , , , , , , , and . We will now look at the performance of these funds and the broader fund RSP in the year-to-date time frame in the following chart.
Source: Yahoo Finance
Therefore, we see that only one out of the 10 ETFs considered have been in the red so far this year. Let’s take a look at the performance of these funds in March (as of March 29, 2017).
Source: Yahoo Finance
Therefore, we see that eight out of the 10 ETFs compared were in the red this month (as of March 29, 2017). The high uncertainty prevailing in the markets weighed on the funds’ performance, bringing down their overall Q1 performance.
To Conclude
What investors should note is that when large-cap stocks are on a trajectory to beat their mid-cap and small-cap counterparts, equal weight funds will underperform the cap-weighted funds. The drawdown in equal weight funds’ performance in March was due to the uncertainty in the markets surrounding President Trump’s policy implementation.
His America First agenda and protectionist stance are currently in question, which is a negative for the domestic economy. The Russell 2000 index, an index tracking major small cap stocks, fell 2.97% in the past one month (as of March 29, 2017) (read: Trump Trade Fades: Top and Flop ETFs of Last Week).
The DOW fell for eight consecutive sessions before ending its losing streak on March 28, 2017 as consumer confidence level surged to a 16-year high. Therefore, even though investors are concerned about the implementation of the President’s policies on tax reform and deregulation, it is prudent to note that the U.S. economy is 70% consumer based, that is an economy driven by consumer spending as a percentage of its GDP. Hence, the consumer confidence number is important.
It is tough to predict how these funds will perform in the months to come, owing to the mixed market sentiments. Hence, we believe it is best to remain on the sidelines for now.
Curious about equal weight investing? See our recent podcast for additional information on this approach:
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What Lies Ahead for Equal Weight Funds After Trump Bump?
Equal weight ETFs, one of the most easy-to-understand forms of ETF investing, do a great job in managing concentration risk, as these allocate an equal percentage of assets to all holdings. This therefore limits the probability of a severe drawdown in assets because of an adverse move in a single security.
The funds are diversified across a range of market caps and lock in gains of short-term winners and buy securities of the losers. However, this exposes investors to short-term volatility because of increased allocation to small cap stocks. Moreover, periodic rebalancing leads to higher transaction costs.
The markets have been surging since Trump was elected on November 8, 2016, mainly due to his promise of tax cuts and reduced regulations on banks. His pro-business outlook had a major impact on the financial markets. However, the Republicans faced a major setback recently.
The first major legislation passed by President Trump, the healthcare bill, was withdrawn on Friday, March 24, 2017. This resulted in reduced confidence among investors regarding the President’s ability to fulfill his other campaign promises, namely tax cuts and review of the Dodd Frank Act (read: Trumpcare Collapse Fuels Rally in Healthcare Stocks & ETFs).
The primary reason that equal weight ETFs outperform their cap-weighted counterparts is their methodology to assign the same weight to stocks across different levels of market capitalization. A large cap stock is assigned the same importance as a mid- or small-cap stock. In domestic bull markets, small-cap stocks outperform their larger-cap counterparts. This is because their major dealings are domestic, as compared to a high international exposure of mid cap and large cap stocks (read: Why Do Equal Weight ETFs Outperform?).
We will now look at the characteristics of the most popular equal weight ETF, RSP.
Guggenheim S&P 500 Equal Weight ETF (RSP - Free Report)
This fund is the most popular ETF in the equal weight space. It tracks the S&P 500 Equal-Weight index.
The fund has AUM of $13.1 billion and charges a fee of 40 basis points a year. Consumer Discretionary, Industrials, and Information Technology are the top three sectors from a holdings perspective with 16.4%, 13.5%, and 13.3% allocation, respectively. The fund returned 15.5% in the past year and 4.7% in the year-to-date time frame (as of March 29, 2017). RSP currently has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.
There are other sector specific equal weight ETFs such as , , , , , , , and . We will now look at the performance of these funds and the broader fund RSP in the year-to-date time frame in the following chart.
Source: Yahoo Finance
Therefore, we see that only one out of the 10 ETFs considered have been in the red so far this year. Let’s take a look at the performance of these funds in March (as of March 29, 2017).
Source: Yahoo Finance
Therefore, we see that eight out of the 10 ETFs compared were in the red this month (as of March 29, 2017). The high uncertainty prevailing in the markets weighed on the funds’ performance, bringing down their overall Q1 performance.
To Conclude
What investors should note is that when large-cap stocks are on a trajectory to beat their mid-cap and small-cap counterparts, equal weight funds will underperform the cap-weighted funds. The drawdown in equal weight funds’ performance in March was due to the uncertainty in the markets surrounding President Trump’s policy implementation.
His America First agenda and protectionist stance are currently in question, which is a negative for the domestic economy. The Russell 2000 index, an index tracking major small cap stocks, fell 2.97% in the past one month (as of March 29, 2017) (read: Trump Trade Fades: Top and Flop ETFs of Last Week).
The DOW fell for eight consecutive sessions before ending its losing streak on March 28, 2017 as consumer confidence level surged to a 16-year high. Therefore, even though investors are concerned about the implementation of the President’s policies on tax reform and deregulation, it is prudent to note that the U.S. economy is 70% consumer based, that is an economy driven by consumer spending as a percentage of its GDP. Hence, the consumer confidence number is important.
It is tough to predict how these funds will perform in the months to come, owing to the mixed market sentiments. Hence, we believe it is best to remain on the sidelines for now.
Curious about equal weight investing? See our recent podcast for additional information on this approach:
Want key ETF info delivered straight to your inbox?
Zacks’ free Fund Newsletter will brief you on top news and analysis, as well as top-performing ETFs, each week. Get it free >>