Small has been beautiful this year on Wall Street. That’s because smaller-cap stocks within the S&P 500 SPX,
have far outperformed the largest-cap stocks since January. The eight stocks with the largest market capitalizations at the start of the year, which at the time accounted for 27.2% of the total market capitalization of the entire index, have lost an average of 40.4% so far this year. year (until November 2018). 21), according to FactSet. That’s more than triple the average loss of 9.5% among the 490-plus remaining stocks in the S&P 500.
it’s the biggest loser to date, down 67.3%, but it’s certainly not the only stock to bring down the average. nvidia nvda,
the 8the the largest stock in the S&P 500 as of early 2022, down 47.9% through the end of October, and Amazon AMZN,
the third largest, down 44.5%. The chart below shows how the eight largest-cap stocks in the S&P 500 at the start of the year have lost more than average.
This stark contrast explains why the equal-weighted version of the S&P 500 Index has outperformed the traditional capitalization-weighted version, the version you see published every day in the financial press. The equal weighting strategy gives each of the stocks that make up the index the same weight in the index, while the capitalization-weighted approach ranks each stock according to its market value. Given that stocks that make up more than a quarter of the S&P 500 Index have lost more than three times the average among all other components, it is not surprising that the year-to-date performance of the capitalization-weighted S&P 500 lags well behind equivalent. weighted version: by 6.0 percentage points.
That’s the largest alpha for the equal-weight version in more than a decade, assuming this 6.0 percentage point differential holds through the end of the year. You have to go back to 2010 to find another calendar year in which the alpha of equal weight was higher. At that time the alpha was 6.3 percentage points.
Of course, the equivalent-weighted version of the index does not always outperform the capitalization-weighted version. Long-term data paints a picture of the two sides in a virtual dead heat. Since 1971, which is the time that S&P Global calculated the return of the equal-weighted version, the equal-weighted version has produced an adjusted dividend yield of 12.2% annualized, as opposed to 10.8% for the capitalization weighted. But the higher performance of the equal weight version came with 13% more volatility, which is a measure of risk. On a risk-adjusted basis, the two are almost neck-and-neck, with equal weight slightly ahead.
This slight advantage largely disappears once transaction costs and management fees are taken into account. Transaction costs are higher for the equal-weight version because, by design, it must undergo more periodic rebalancing transactions than the maximum-weight version. The annual turnover rate of the SPDR S&P 500 ETF Trust SPY,
is 2%, for example, in contrast to 38% for the Invesco S&P 500 Equal Weight ETF RSP,
Management fees are also higher for the Invesco ETF (0.20% pa of assets under management) than for the SPDR product (0.0945% of AUM).
The Invesco ETF has only been around since 2003, so we only have two decades of real-world experience for the two weighting schemes. Since then, the equal-weight ETF has slightly outperformed the SPDR ETF on a raw, unadjusted basis, but lagged on a risk-adjusted basis.
what to expect
Lawrence Tint, the former US CEO of Barclays Global Investors, the organization that created iShares (now part of Blackrock), thinks it’s a game of chance which weighting scheme will work best in the coming decades. In an interview, Tint said there will be times when larger-cap stocks will suffer disproportionately, like this year, and when that happens, the cap-weighted version will lag the equal-cap version. But, Tint added, there will be other times when it’s the complete opposite.
Tint said he’s not aware of any theoretical reason why the relative advantage should always be one way or the other.
Tint’s argument is historically supported by the chart above, which plots the difference over the past 10 years in annualized returns of the equal-weighted and maximum-weighted versions of the S&P 500. This difference has oscillated between periods of equal overperformance and underperformance. weighing. Please note that these returns are calculated based on the theoretical returns of the indices themselves and do not take into account transaction costs or management fees. Based on the post cost and post fee, the data series on the chart would shift down.
One approach you might take in deciding between capitalization and equal-weighted versions of the S&P 500 is your tolerance for volatility-related risk. Since the equal-weighted version has historically been 13% more volatile than the capitalization-weighted version, you might consider it the functional equivalent of buying the capitalization-weighted version at 13% margin.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at firstname.lastname@example.org