Market weight and equal weight S&P 500 ETF: an overview
Think of the S&P 500 index as a pie chart: For a market-weighted ETF, the pie chart is divided into sections based on market value. For equal-weight ETFs, regardless of the size of the company or industry, all slices have the same size.
There are exchange-traded funds (ETFs) that track each of these two indexes, but even if their funds come from the same company, their behavior is very different and can have a significant impact on investment.
In January 2003, the S&P 500 Equal Weight Index (EWI) was created. As the name suggests, this is an equal weighted version of the popular S&P 500 index. Although the two indices are composed of the same stocks, different weighting schemes result in the two indices having different attributes and different returns to investors.
- You can trade ETFs that represent the traditional S&P 500 index and the newer S&P 500 index of equal weight.
- The normal market-weighted S&P 500 index does require regular adjustments, but does not need to be rebalanced. ETFs with equal weights require both.
- If a large sector experiences a downturn, equal-weight ETFs can provide more protection. Due to the same weights, underperforming small sectors can offset more losses than market-weighted ETFs.
- Just because these two types of ETFs hold the same basket of subsidiaries, it does not mean that they perform similarly.
Standard & Poor’s 500 Index Market Weighted ETF
Similar to many stock indexes, the Standard & Poor’s 500 Index is a market capitalization weighted index. The market value of each stock is determined by multiplying the stock price by the number of outstanding shares. The company with the largest market capitalization or value has the highest weight in the index.of
Although many companies make up the S&P 500 index, the industry weight of the MWI (market capitalization weighted index) is calculated by adding up the weights of the companies that make up the industry.The ETF of choice for the S&P 500 Index is the State Street SPDR S&P 500 Index (ARCA: SPY).of
The weight of a company in the index is equal to the company’s market value divided by the total market value of all companies in the index. For example, as of December 2020, the largest component of the S&P 500 index is Apple (NASDAQ: AAPL), which is weighted at 6.65% of the total index. The top ten constituent stocks of the S&P 500 index account for 27.2% of the index.of
S&P 500 Equal Weight ETF
The equal weight index is exactly what its name suggests. Regardless of the size of the company, every stock in the index has the same weight. Therefore, even Apple will have the same weight as the smallest company in the S&P 500 index (0.2%).
Invesco S&P 500 equal weight ETF (ARCA: RSP) tracks EWI and is the most frequently traded equal weight ETF.
For EWI, industry weight is actually a direct function of the number of companies in that industry. For example, if a sector contains 45 stocks, the weight of the sector should theoretically be (45 / 500) x 100 = 9%.
The following table is the calculation of the five hypothetical stock indexes, comparing the market weight and the equal weight calculation.
|Market value weighted and equal weight index construction example|
|in stock||return%||Mark weight%||Equal weight%||Contribute to Mkt.weight||Contribution equal weight|
|Global Health Index||7||10||20||0.70||1.40|
|Mobile network operator||12||3||20||0.36||2.40|
The different weighting schemes of the Standard & Poor’s 500 Index EWI and Standard & Poor’s 500 Index will also result in different industry risk exposures.
The following table shows the industry weight difference between the two indexes as of March 31, 2020. For example, in MWI, the weight of the information technology industry is 25.5%, while in EWI it is only 15.6%. In EWI, industrial stocks are 14%, but their weight in S&P 500 MWI is only 8.2%. Understanding the difference in sector composition will help determine which index to use.of
|Department||Standard & Poor’s 500 Index||S&P 500 Index EWI|
Special considerations: volume and volatility
Adjustments will be made to reflect companies that have been deleted and new companies that have been added to the index. There will also be adjustments for companies in the index to issue new shares or exit existing shares.
For the Standard & Poor’s 500 EWI, the goal is to maintain a portfolio of 500 equi-weighted stocks while keeping the index turnover rate at a minimum. The weight of each stock in the index is 0.20% (1 / 500 x 100). The Standard & Poor’s 500 Index EWI is re-adjusted every quarter to match the quarterly share adjustment of the Standard & Poor’s 500 Index on the third Friday of each quarter. Stocks that performed well in the previous quarter will be sold, and those that performed relatively poorly will have to be bought to ensure equal weight. This is essentially a sell-high-buy-low strategy. However, rebalancing will result in additional transaction costs for ETFs.of
Compared with the S&P 500 index, the S&P 500 EWI tends to have higher volatility. According to the official S&P Dow Jones Index fact sheet data released on March 31, 2020, in the past five years, the annualized standard deviation of the S&P EWI was 15.51% and the S&P 500 index was 13.65%.This reflects the fact that small-cap stocks are generally more volatile than large companies, and the S&P 500 index EWI is more inclined to small-cap stocks than the S&P 500 index.