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U.S. market diversification with an Equal weight index ETF.

Does an Equal-weight U.S. ETF diversify and complement a U.S. market cap-based ETF?

It does.

Compare the top 10 of the S&P 500 market cap weighted (SPY) to the Rydex S&P 500 equal weight ETF (RSP). (Compare to iShares’ IVV, Vanguard’s VV, BMO’s ZEU (hedged) … they are nearly identical to SPY. Claymore US fundamental weight ETF CLU.C isn’t much different).

State Street Global Advisors S&P 500 market cap index ETF (SPY) MER 0.10% S&P 500 Equal-weight index ETF (RSP) MER 0.40%
Exxon Mobil 3.43% NVIDIA CORP 0.32%
Apple Inc 2.66% MICRON TECHNOLOGY 0.25%
General Electric 1.85% MARATHON OIL 0.25%
Microsoft 1.80% WEYERHAEUSER 0.25%
IBM 1.70% DEAN FOODS 0.24%
Chevron 1.62% CHESAPEAKE ENERGY 0.24%
Procter & Gamble 1.55% MASSEY ENERGY 0.24%
JP Morgan Chase 1.50% BAKER HUGHES 0.24%
Wells Fargo 1.44% INTUITIVE SURGICAL 0.24%
Johnson & Johnson 1.42% DEVON ENERGY 0.23%

What about performance?

1 Year 10 Year 20 Year
S&P 500 Market cap weighted 15.0% 1.4% 9.1%
S&P 500 Equal weighted 21.9% 6.2% 11.8%

To December 31, 2010, small-mid caps have outperformed large cap stocks. The performance differential is due to what Credit Suisse empirical data indicates is the long-term premium for a portfolio skewed towards small and mid caps. An Equal weight ETF skews the portfolio toward smid caps.

Next time?

Does a GDP weighted index complement and diversify a market cap index?

Doug Cronk, CFA is Manager, Investments for a Canadian Pension fund.

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