The issue of using different index weighting methodologies in ETFs is a topic that we have discussed on more than one occasion.  In the article titled, “The Weight Debate” posted on February 7th, we highlighted the difference in performance across several weighting methodologies including capitalization weighting, equal weighting, fundamental weighting, and relative strength weighting.  What we find is that altering the way in which you weight the components of a particular index can have a profound impact on returns.  Today, we wanted to turn our focus specifically to the equal weight versus cap weight debate as it relates to the S&P 500 Index, which is one of the most widely used domestic equity benchmarks.

There are many ways to buy the cap-weighted S&P 500 Index in ETF form.  In fact, the SPDR S&P 500 ETF Trust (SPY) provided by State Street Global Advisors was launched back in 1993, and it was the first exchange traded fund available for investment.  Still to this day, it remains the largest ETF with more than $77 billion in assets under management (AUM).  Since 1993, nearly every other major ETF provider has launched a fund that also tracks the cap-weighted S&P 500 Index; yet there is just one ETF that allows you to invest in these same 500 stocks on an equal weighted basis, the Rydex S&P 500 Equal Weighted Index ETF (RSP).   As of March 31, 2011, the RSP had a little over $2 billion in AUM (source: National Stock Exchange), which is only a fraction of the assets housed by the SPY. 

Interestingly, just the difference in the weighting between these two ETFs has accounted for a 56% discrepancy in returns over the last decade.  As you can see in the graph below, If you invested $10,000 in the SPY back on April 29, 2001, you would now have $10,857.00; however, if you took that same $10,000 and bought the RSP instead, the portfolio value would now be $16,468.00!  What is even more notable is the fact that the RSP recently returned to its all time high of $52.00 per share, that it formed back in May of 2007.  The SPY is still about 15% off its 2007 high water mark of $156.  With that said, those who have utilized an equal weighting methodology with respect to the S&P 500 Index have fully recouperated from all that the bear market of 2007-2009 inflicted, while those investing in the cap-weighted funds are still realizing a loss over the last few years.