Equal weighted ETFs - better or worse than regular index ETFs?

What are equal weighted index finds?

If you look at the components of an index fund such as S&P500, you will see that large companies are overrepresented. Even if  the index holds 500 companies they are not equally represented.

As you see below in the example of SPY ETF which tracks S&P 500 index, Apple comprises 3.94% of the index and the top 10 holdings represent not 10% but 20% of the index.

Here is the example of QQQ and Apple stock is also overrepresented. The top 10 holdings represent over 50% of the ETF value.  

An equal weighted index fund will hold the same set of companies as its underlying index but the value amount be equally distributed.  

RSP is the equal weighted ETF corresponding to SPY and QQQE is the equal weighted ETF corresponding to QQQ.
The expense ratios are higher due to higher turnover and the equal weighted ETFs may produce more capital gain distributions. But are they a better choice for the investor?

The non-equal weighted indexes are weighted by market capitalization. When a stock is increasing in price, the index will increase the amount of stock that is going up. If the stock goes down, the index will decrease the amount of stock held. Basically it is going with the trend.

The equal weighted indexes are more contrarian. The funds are divided equally between all held stocks. If a stock goes down in price, it will be bought and the opposite with the rising in price stocks - they will be sold to keep the equal shares.
This will lead to sell high and buy low. It also may lead to keep buying a stock which will never get up again. But since one possible big loser stock will only be 1/500 the risk is contained. During the recession when the stock prices are going down, more stocks will be bought at a lower price  buy the equal weighted ETFs compared to the non-equal weighted ETFs.

How did their performance compared during last recession? 
 
Here is SPY compared to RSP. This timeframe includes year 2009.

However in the last 5 years there is no significant difference in performance.  
 

 

And in the last year the non-equal weighted SPY outperformed the equal weighted RSP.

 

Now let's compare QQQ and QQQE. In this case the non-weighted QQQ over performed the equal-weighted QQQE in the long term.

The same for the last 5 years:

And for the last year:

Whatever the explanation is, the results are variable.

The expense ratios for equal weighted ETFs are higher (SPY 0.09%, RSP 0.20%, QQQ 0.20% and QQQE 0.35%).

The main advantage of the equal weighted ETFs appears to be in the diversification - they are more diversified compared to the non-weighted ETFs.  

What is "Indexing"?

Indexing is a passive long term investment strategy.

Indexing can be achieved with mutual funds or exchange traded funds (ETFs) which closely tack the performance of the underlying index.


SPDR S&P 500 ETF (or SPY) is an example of an ETF which closely tracks S&P 500 index.
SPY holds 500 companies that make up S&P 500. 
People like indexing because with little effort this is a way to diversify. The 500 companies of the SPY are supposed to be approximately 80% of the overall US stock market.


With this method the investor will:
1. Achieve the same rate of return as the underlying index.
2. Will be exposed to the same risks as the underlying index.
3. Achieve a good degree of diversification.

Most of my investments are in index funds at this time. As mentioned above, it is easy, it is diversified and the return averages are acceptable. 

I have another post about how I do indexing for myself: Indexing simplified.