Checking In On Equal-Weight ETFs This Year

The world of indexing is typically dominated by market capitalization weighted methodologies that give the largest allocation to the biggest stocks. However, that can often lend itself to these mega-companies having too great of a pull on the performance of the overall strategy.

For example, the PowerShares QQQ Trust, Series 1 (NASDAQ: QQQ) tracks the 100 largest non-financial stocks on the NASDAQ stock exchange using a market cap weighted approach. The largest holding in QQQ is Apple Inc. (NASDAQ: AAPL), which accounts for 14 percent of the total assets. Apple is therefore in a position to significantly influence the total return of the fund.

A varying style to the market cap index is an equal-weighting methodology that gives every stock in an established index a proportionate share of the asset allocation. This allows for smaller companies to have a more pronounced impact on the total return of the fund.

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The First Trust NASDAQ-100 Equal Weighted Index Fund (NASDAQ: QQEW) is the equal-weighted peer of QQQ and owns the same underlying 100 stocks. Each stock within the index is given a 1-percent allocation of the total assets and rebalanced on a quarterly basis.

So far this year, QQEW has slightly underperformed the benchmark index because of the generous returns of mega-cap stocks such as Apple and Microsoft. However, this could certainly change if the largest companies started to lag their smaller competitors.

Equal-weight ETFs typically shine during market cycles that favor smaller companies within the same industry group or sector.

The most well-known equal-weight index is the Rydex S&P 500 Equal Weight ETF (NYSE: RSP), which has more than $9.1 billion in total assets. Interestingly enough, RSP is moving almost in lock step with its market cap equivalent SPDR S&P 500 ETF (NYSE: SPY) this year. Both ETFs have gained approximately 10.5 percent since the beginning of 2014.

While the equal-weight methodology hasn't had a significant impact on total return this year, in past instances it has added notable outperformance. Last year for instance, RSP added more than 3 percent in additional return versus SPY.