An analysis of S&P 500 exchange traded funds (ETFs) by Standard & Poor’s Equity Research shows that not all such funds are alike and that investors must look under the hood at each fund’s stock weightings before choosing an ETF for their portfolios.
In a comparison of the SPDR S&P 500 ETF (SPY) versus the Rydex S&P Equal Weight ETF (RSP), S&P Equity Analyst Todd Rosenbluth found that SPY had a relatively strong 12-month period as of June, rising 32.9%, but the ETF lagged RSP, which climbed 38.1%.
However, because RSP is constructed differently from SPY, giving equal weighting to all stock holdings in the S&P 500 versus SPY’s more heavily weighted holdings in the biggest companies, S&P Equity Research favors SPY with an Overweight rating compared to RSP’s lower Marketweight rating.
“People tend to choose an ETF based on the cost and how well it matches the benchmark,” Rosenbluth said in a phone interview on Tuesday. “But we think people need to look under the hood and understand that the stocks that are actually in their ETFs are different from each other because the largest positions are not the same. If you think that the larger positions are undervalued and less risky, as we do, then SPY is a better option even though the Rydex ETF offers more diversification.”
But Craig Callahan, president of ICON Advisers, a mutual fund company based in Greenwood Village, Colo., warns that market cap weighted indexes such as SPY are not for every investor.
“Whenever you put together a portfolio or index that’s market cap weighted, you’ve taken on a momentum strategy without knowing it,” Callahan said.
With a momentum strategy, an investor is buying the stocks that are performing well and thus weighted more—“and that’s fine, but when you reach a peak, you go the other way and get clobbered,” he said. “You’re invested in what has been leading, so you’re accumulating more and more of what was hot and less and less of what is leading.”