When Diversification Matters, Go for Equal Weighting

The S&P 500 EWI is designed to be a size-neutral version of the S&P 500. It includes the same components as the capitalization-weighted S&P 500, but each company in the S&P 500 EWI is assigned the same weight at each quarterly rebalance .

The simple arithmetic of rebalancing links equally weighted indices to momentum effects. If the price of a component increases more than the average of its peers, then its weight in the portfolio will increase and the position will necessarily be reduced during the next rebalancing when the portfolio returns to equal weights, according to the S&P Dow Jones indices. .

On the other hand, if a stock falls more than the average of its peers, its weight will also drop and more will have to be bought at the next rebalance to return to an equal weight. Thus, equal-weight indices sell relative winners and buy relative losers with each rebalancing, according to the S&P Dow Jones Indices.

The sector allocation of the cap-weighted S&P 500 versus the equally-weighted S&P 500 is important for investors to consider.

Information technology is the largest sector in each index, although there is a fairly large gap between the two. According to the S&P Dow Jones Indices, holdings in information technology in the equally weighted index are 15.3%, compared to 28% in the capitalization weighted, according to the S&P Dow Jones Indices.

In the equally weighted index, information technology is followed by industrials and financials, rounding out the top three sectors at 14.4% and 13.3%, respectively, according to the S&P Dow Jones indices.

Healthcare holdings are at 13%, consumer discretionary at 11.6%, consumer staples at 6.4%, utilities at 5.8% and real estate at 5.7%.

The bottom three sectors in terms of exposure are Materials, Communication Services and Energy, which account for 5.6%, 4.6% and 4.1% respectively.

The greatest spread

The gap between sectors is much larger when looking at the market-cap-weighted index.

Information technology has a huge lead over other sectors in the market-cap-weighted index. The second and third sectors by weight are healthcare and consumer discretionary, which represent 13.6% and 12% respectively, according to the S&P Dow Jones indices.

Financials account for 11.1%, Communication Services 9.4%, Industrials 7.9% and Consumer Staples 6.1%.

Finally, four sectors are weighted at less than 5%, including the best performing sector for the whole of 2021 and the first quarter for 2022, energy. Energy represents only 3.9%, utilities and real estate 2.7% each and materials 2.6%.

An equally weighted strategy, such as Invesco S&P 500® Equal Weight ETF (RSP) or the Invesco ESG S&P 500 Equal Weight ETF (RSPE)can provide diversification benefits and reduce concentration risk by weighting each constituent company equally so that a small group of companies does not have an outsized impact on the index.

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