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The Amazing Beauty Of Equal Weight

Summary Most investors look only at capital-weighted indices. They miss two positive anomalies of equal weight. Here are equal-weight ideas and ETFs for passive investing and tactical allocation. Capital-weighted indices in the broad market and specific sectors are getting all the attention of investors. This article aims at proving that equal-weighted indices are better investment vehicles for passive investing and tactical allocation. We will stay in the S&P 500 universe. A few words of theory The statistical bias in favor of an equal weighted set of stocks over the same set weighted on market capitalization has two reasons: Size effect: Lower-range large-caps usually perform better than mega-caps. Rebalancing: Periodically equalizing position sizes in dollar amount among a big set of stocks is a simplistic “buy-low-sell-high” strategy. Simplistic, but not stupid. The interest bias in favor of capital-weighted indices has also good reasons: It is a good representation of real economic activity. Inheritance of the pre-computer era, capital-weighted indices are easier to calculate manually. They are linear functions of share prices, adjusted of structural and corporate events (component list modifications, splits, public offerings, buybacks). It generates less transaction costs for a mutual fund or ETF following it. Equal-weighted S&P 500 The next chart shows in red the equity curve of all S&P 500 stocks, equal-weighted rebalanced on weekly opening between January 1999 and September 2015. The blue line is SPY . In both cases, dividends are accounted and reinvested. It is impossible to implement as a strategy for an individual investor because of the capital needed to absorb transaction costs. Moreover, there is an ETF for that: the Guggenheim S&P Equal Weight ETF (NYSEARCA: RSP ). Since inception on 4/24/2003, it has an annualized excess return of 2% over SPY, making it a better instrument of passive index investing. On the same period, the theoretical annualized excess return of equal-weight S&P 500 with dividends is 3.5%. The difference can be explained by trading costs, management fees, rebalancing frequencies. Next chart: RSP in red versus SPY in blue since 4/24/2003: (click to enlarge) S&P 500 with sectors in equal weight The next chart shows the equity curve of an equal weight portfolio of the 9 Select Sector SPDR ETFs rebalanced weekly: utilities (NYSEARCA: XLU ), energy (NYSEARCA: XLE ), materials (NYSEARCA: XLB ), financials (NYSEARCA: XLF ), healthcare (NYSEARCA: XLV ), industrials (NYSEARCA: XLI ), IT & telecom (NYSEARCA: XLK ), consumer staples (NYSEARCA: XLP ), and consumer discretionary (NYSEARCA: XLY ). Here, the size effect is questionable, but the rebalancing bias applies. (click to enlarge) Individual sectors in equal weight Guggenheim has also sector equal-weight ETFs. The next table compares their annualized returns with the Select Sector SPDR series since inception date (11/1/2006), and the theoretical return of stocks rebalanced weekly in equal weight: Sector Stocks Eq. Weight weekly Eq. weight ETF Ann. return Cap. weight ETF Ann. return Cons. Disc. 9.76% (NYSEARCA: RCD ) 8.63% XLY 9.96% Industrials 9.08% (NYSEARCA: RGI ) 7.64% XLI 7.01% Cons. Staples 12.61% (NYSEARCA: RHS ) 11.72% XLP 9.92% Materials 7.63% (NYSEARCA: RTM ) 6.73% XLB 5.16% Energy 2.83% (NYSEARCA: RYE ) 1.97% XLE 3.26% Financials 2.46% (NYSEARCA: RYF ) 0.02% XLF -2.63% Healthcare 14.91% (NYSEARCA: RYH ) 14.18% XLV 10.96% Technology 8.41% (NYSEARCA: RYT ) 6.95% XLK 8.32% Utilities 7.24% (NYSEARCA: RYU ) 6.33% XLU 5.59% In theory, equal weight brings a better or similar return in all sectors, except energy. After management fees and tracking errors, the consumer discretionary and technology equal-weight ETFs are also failing. Equal weight of equal-weighted sectors As a last paragraph, here is the return since the inception of the Guggenheim ETFs in equal-weight rebalanced weekly compared with the Sector SPDR ETFs in equal weight, RSP and SPY. 1/01/2006-09/16/2015 Guggenheim series eq. weight SPDR series eq. weight RSP SPY Ann. Return 8.35% 7.16% 7.43% 6.31% The solutions with individual stocks in equal weight for each sector work better (1st and 3rd columns), which makes sense: size effect is more beneficial. For an individual investor seeking an equal-weight strategy on the broad index, RSP may be a better solution than the Guggenheim series in equal weight after transaction costs, depending on transaction fees and portfolio size. Conclusion With the exception of the energy sector, equal weight has been systematically superior to capital weight in the S&P 500 universe on the 2 last market cycles (1999-2015). In ETF implementations, fees and tracking errors result in a lag for 2 other sectors. Investors can find here useful investing instruments and ideas for passive investing and sector tactical allocation. Data and charts: Portfolio123 Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: I short the S&P 500 for hedging purposes

ETFs To Watch On Increasing Consumer Credit

The Federal Reserve reported on Tuesday that consumer credit increased in July, an indication of rising consumer confidence in a favorable economic environment. It was reported that the volume of consumer credit rose by $19.1 billion or at an annual rate of 6.7% in July, outpacing the consensus estimate of $18 billion. This was preceded by a gain of $27 billion in June. Moreover, with July’s increase, consumer credit finished in the positive territory every month for nearly four years. According to the report, revolving credit in July increased at an annual pace of 5.7% after surging 10% in June. Non-revolving credit, which includes auto and student loans, also witnessed a gain of 7%, preceded by June’s rise of 9.4%. This encouraging report indicated that consumers who play an important role in boosting the U.S. economy are gradually gaining confidence on the back of a recovering economy, low oil prices and a steady labor market. Consumers Boosting Economy The rise in consumer spending has helped the U.S. economy to rebound strongly in the second quarter after witnessing sluggish first-quarter growth. The “second estimate” released by the U.S. Department of Commerce showed that the GDP in the second quarter advanced at a pace of 3.7%, compared to the first quarter’s rise of only 0.6%. According to the report, consumer spending, which contributes more than 75% to economic activity, rose 3.1% during the second quarter, outpacing the first quarter’s growth rate of 1.8%. It contributed more than 2.1% to the second-quarter GDP, the highest by any segment. Meanwhile, the consumer credit report indicated that auto loans – a key component in the non-revolving credit segment – played an important part in boosting debt volume in this section. This is evident from the encouraging auto sales report released recently. In August, automakers witnessed the highest rate of increase in light vehicle sales in the U.S. in 10 years. Along with factors such as low oil prices, a recovering economy and an improving labor market condition, easy availability of credit with lower interest rates and longer repayment periods also helped consumers to spend more in the auto sector. Factors Lifting Consumer Sentiment A steady job market had no little impact in the recent boost to consumer sentiment. Though the U.S. job numbers in August grew at the most sluggish pace in five months, the unemployment rate dropped to 5.1% from 5.2%, the lowest since April 2008. Moreover, the job report showed that average hourly wages rose 0.3% sequentially and 2.2% year over year. Meanwhile, the slump in oil prices is another important factor that enabled U.S. consumers to spend more over the past few months. Oil price skidded to half over the past one year amid increasing production, a large supply glut and sluggish demand. The situation is hardly expected to improve in the near future, as there is little hope of a reduction in oil supply. While the U.S. and Organization of Petroleum Exporting Countries (OPEC) are still producing oil at multi-year highs, Iran is looking to boost its production once the Tehran sanctions are lifted. ETFs to Consider ETFs exposed to sectors that attract a major part of consumer spending are poised to gain from this bullish consumer credit report. As mentioned above, the auto sector was one to receive a significant part of consumer credit in July. In this situation, investors may consider the auto ETF – the First Trust NASDAQ Global Auto ETF (NASDAQ: CARZ ) – in order to tap the positive trend. CARZ holds a Zacks ETF Rank #2 (Buy) and gained nearly 3.9% yesterday and around 3.4% over the past one week. Separately, another sector that receives a notable share of consumer spending is consumer discretionary. Positive consumer credit data also had a positive impact on ETFs that are exposed to this sector. Among them, the Consumer Discretionary Select Sector SPDR ETF (NYSEARCA: XLY ), the SPDR S&P Retail ETF (NYSEARCA: XRT ) and the iShares U.S. Consumer Services ETF (NYSEARCA: IYC ) gained 2.3%, 2% and 2.3% yesterday, respectively. The ETFs mentioned above hold either a Zacks ETF Rank #1 (Strong Buy) or a Zacks ETF Rank #2 (Buy) and may thus be on the radar of investors looking to gain from the favorable scenario. Original Post