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Advisors that have been in business for several decades might remember the following. Back in the 1980s, Dean Witter Reynolds introduced the Dean Witter Value Added Market Series.
In simple terms, that offering was one of the first – perhaps the first – iteration of an equal-weight fund. It equally weighted the components of the S&P 500 under one umbrella. At the time, that was a novel approach and one that, for years, didn’t bear fruit for investors. Consider the following from a July 1997 Wall Street Journal article by Karen Damato.
“Unfortunately for investors in the Dean Witter fund, the giant ‘megacap’ stocks that dominate the S&P index have been star performers over the past few years. That has made the Dean Witter Value-Added formula a recipe for value-subtracted performance vs. the index. Over the three years through June, the Dean Witter fund returned an annualized 21.8%, according to fund researchers Morningstar Inc. -- far behind the 28.8% return of the S&P index and the 28.7% return of the Vanguard Index 500.”
To say the least, that’s not impressive and at that time, advisors would have been right to ponder why equally weighting stocks was worth the trouble if the endeavor didn’t result in better returns than weighting by market capitalization.
Equal-Weight Now on Long Resurgence
Owing to the long-running disappointment of the Dean Witter Value Added Market Series, advisors could be forgiven if they took their eyes off the equal-weight ball.
Hopefully, they didn’t do that because the methodology kicked into high gear in 1998. Five years later, it was made more accessible and cost-effective with the debut of the Invesco S&P 500® Equal Weight ETF (NYSEARCA: RSP), which celebrated its 20th birthday a few weeks ago.
Today, RSP is a $32.26 billion exchange traded fund with a lengthy track record of beating the cap-weighted S&P 500. Of course, RSP and equal weighting in general have their critics, which usually hang their hats on the methodology leaning into the size and value factors. However, the value assertion doesn’t explain how RSP generated admirable performance for the decade ending 2021 – a period in which growth consistently outpaced value.
“The equally weighted portfolio punched well above its weight, because it finished above both of its influences rather than somewhere in the middle,” notes Morningstar’s John Rekenthaler. “Which leads to the following question: Would investors have been better off owning an equally weighted fund than placing half their assets into a small-company fund and half into a value-stock fund?”
Sometimes, ‘Why’ Doesn’t Matter
Understandably, advisors want to know why a particular strategy outperforms or lags. That’s just human nature and in the case of advisors, knowing the “why” is important in terms of articulating and illustrating examples to clients.
However, in the case of RSP, getting hung up on why it beats small-cap value and large-cap blend indexes isn’t necessary. Just know that the ETF has delivered the goods for clients, though past performance isn’t a promise of future returns.
“Dean Witter’s fund suffered from poor timing, and even more greatly from absurdly high expenses. Its failure tarnished the reputation of equally weighted indexes. As the past 25 years have demonstrated, though, the concept clearly possesses merit,” concludes Rekenthaler.
If there’ a rub with equal-weight ETFs for advisors to note, it’s that these products, due to more frequent rebalancing, aren’t as tax-efficient as they’re cap-weighted counterparts. That means some cost-conscious clients may want to avoid this strategy or embrace it only in small doses.
Related: Why Thematic ETFs Still Matter