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When Reverse Is The Way Forward

July 20, 2018 8:43 am
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One of the most popular images making the rounds on Financial Twitter this week comes courtesy of Ritholtz Wealth Management Director of Research Michael Batnick.

The long and short of it is, as of July 18, the top five companies in the S&P 500 had a combined market value of $4.095 trillion. That is slightly ahead of the combined market capitalization of $4.092 trillion for the bottom 282 S&P 500 components.

What To Know

The top five members of the S&P 500 are, in order, Apple Inc. (NASDAQ:AAPL), Microsoft Corporation (NASDAQ:MSFT), Amazon.com, Inc. (NASDAQ:AMZN), Facebook Inc. (NASDAQ:FB) and Berkshire Hathaway Inc. (NYSE: BRK-A). Those stocks combine for 14.12 percent of the S&P 500's weight as of July 19.

Just over 14 percent spread across isn't a massive percentage, but the reality is owners of S&P 500 index funds and exchange traded funds have more exposure to the index's top five names than 282 other stocks in the index.

The Reverse Cap Weighted U.S. Large Cap ETF (CBOE: RVRS), which debuted in November, ameliorates some of the concentration and cap-weighted issues associated with traditional S&P 500 funds.

Why It's Important

RVRS uses a smallest-to-biggest methodology, meaning it weights the S&P 500 in reverse order of market value. The index's largest components, including the aforementioned stocks, take on smaller weights in RVRS.

“Reverse cap weighting results in a weighted average market cap that is both significantly lower than market cap weighted large cap funds, and significantly higher than mid cap funds,” according to Exponetial ETFs, the issuer behind RVRS.

When RVRS debuted in November, the weighted average market capitalization of its holdings was $16 billion, or less than 10 percent of the $162 billion on the traditional S&P 500.

The Reverse Index “captures the size premium, or 'small minus big' within large cap. By keeping the size bet in the large cap space, we believe that the quality, liquidity and valuation issues that have called the size premium into question are largely solved,” said Phil Bak of Exponential ETFs.

What's Next

While the top five holdings in the traditional S&P 500 combine for over 14 percent of the index's weight, the top five members of RVRS combine for just 3.47 percent of that ETF.

RVRS devotes about 34.4 percent of its weight to the consumer discretionary and industrial sectors compared to 22.5 percent assigned to those groups in the cap-weighted S&P 500.

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