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ETF Specialist

ETF Spotlight: Rydex S&P 500 Equal Weight

This ETF is an expensive mid-cap stock index by another name.

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Since inception this fund has outpaced the market-weighted S&P 500. Equal-weighting's boosters claim the strategy beats the market by eliminating market-weighting's growth bias. However, researchers have found that equal-weighting has generated almost all its excess return by tilting to mid-cap stocks and a tiny bit to value stocks. Overlaying  Vanguard Mid-Cap ETF's (VO) price chart on  Rydex S&P 500 Equal Weight's (RSP) chart shows almost identical performance. But VO pulls away when dividends are counted, owing to its lower fees.

To see why an equal-weighted S&P 500 would behave like a mid-cap index, consider how equal-weighting redistributes stock risk. As of the end of August, the S&P 500's largest holding was  Exxon Mobil (XOM), with a $360 billion market cap; its smallest,  AK Steel (AKS), has a market cap just a hair under $1 billion--well into small-cap territory. With RSP equally weighting both stocks, one might be tempted to conclude that both matter equally to the ETF's performance. However, the small-cap AKS moves much more violently than stodgy XOM, amplifying the smaller firm's influence. In a similar manner, the other small- and mid-cap stocks' volatilities come to dominate the equal-weight strategy's performance.

Samuel Lee does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.