Video Reports

Embed this video

Copy Code

Link to this video

Get LinkEmbedLicenseRecommend (-)Print
Bookmark and Share

By Michael Rawson, CFA | 01-07-2011 01:19 PM

Understanding 'Equal Weight'

Equal-weighting the S&P is a more rational way of thinking about exposure, says Rydex's Tony Davidow, while the regular rebalancing discipline adds value over time.

Michael Rawson: Hello, I am Michael Rawson, ETF analyst with Morningstar.

ETFs have been a growth area of the market, but when people think of ETFs, they either think of boring index funds or scary high frequency trading.

Those criticisms really don't apply to the Rydex S&P Equal Weight fund.

Joining me today is Tony Davidow, managing director with Rydex. Tony, thanks for joining me.

Tony Davidow: Mike, thanks for having me.

Rawson: Absolutely. Rydex S&P Equal Weight takes the stocks that are in the S&P 500, those large-cap stocks that we're all familiar with, but instead of market cap weighting them, it equal weights them. Now a common criticism of this approach is that you're basically giving a small-cap tilt and any boost in performance is coming from taking on risky small-cap exposure. How do you respond to that criticism?

Davidow: I think as a starting point, yes, we own the same 500 names that are in the S&P, and we equal weight them. So, although we do benefit from a little bit more of a small-mid exposure, we're actually owning large-cap stocks. The smallest name in the S&P today is Office Depot. We would argue it's a more rational way of thinking about exposure in the portfolio and I'll give you one example.

If you look at the largest name, Exxon and you look at the smallest name, Office Depot, you are making a 300 times bet on the performance of Exxon relative to Office Depot. We would just argue, equal weighting is a more rational of diversifying your exposure. We do benefit from more small- and mid-cap exposure, but it's not a small cap play per se.

Rawson: Okay. However, small caps have had a tremendous run over the past 10 years, certainly they've done much better than large caps. Now in the late 1990s during the go-go years for the tech bubble, large caps performed very well. Small caps sort of underperformed. Does the recent good performance in small caps concern you going forward that that trend might reverse?

Davidow: It doesn't. We've actually looked at long-term historical periods, and we've generally performed quite well. Again, we're providing more diversified exposure. A period of time that we might not perform as well would be a period when the market was dominated by mega-cap names. I am not sure that any one is predicting that mega caps again will dominate the market as they did in the late '90s. So we feel very comfortable with the composition of the portfolio, and we feel very comfortable about their long-term results.

Rawson: Now there are two other aspects to the equal-weighting strategy besides the small-cap tilt. There are two other aspects that I'd like to discuss. First of all, by rebalancing every quarter back to equal weight, it forces you to buy low and sell high. So it has this disciplined aspect to it.

Secondly, there is a reduced concentration in those mega-cap names. In the S&P 500 some people are surprised to learn that a huge portion of their portfolio is actually invested in just a handful of stocks. That's not the case with the Rydex Equal Weight because every stock is equal weight, so you have less exposure to mega cap stocks. Could you talk about these two alternate strategies in Rydex Equal Weight?

Read Full Transcript
{0}-{1} of {2} Comments
{0}-{1} of {2} Comment
  • This post has been reported.
  • Comment removed for violation of Terms of Use ({0})
    Please create a username to comment on this article