#78 Equal-weighted ETFs: real added value or unnecessary?

Most well-known stock indices, such as the SPI, the SMI, the S&P 500, or the MSCI World, weight the companies they include based on their market capitalization. In practice, this leads to concentration: In the Swiss Performance Index, for example, Novartis, Roche, and Nestlé together account for about 37 percent of the total weight. A similar pattern is evident in the U.S. S&P 500, where the ten largest holdings dominate with nearly 40 percent.

With a market-weighted index fund, you are therefore investing heavily in a handful of large corporations. Equal-weighted indices circumvent this concentration by assigning each company in the index exactly the same weight. Equal-weighted indices thus fall into the category of so-called smart-beta strategies, which deliberately deviate from pure market capitalization. Are equal-weighted ETFs therefore the better choice? Unfortunately, there is no one-size-fits-all answer.

Better diversification, but at what cost?

When viewed in isolation, an equally weighted index does, on paper, offer a more even distribution and thus greater diversification in terms of company size. However, this advantage comes at a price.

Long-term studies show that a significant portion of the positive total return of stock markets is driven by a few high-flyers. These are companies that have been exceptionally successful in the real economy over decades. As a result of this success, their market capitalization naturally grows significantly.

In an equally weighted index, however, these long-term winners are assigned only the same small weighting as any other company. This comes at the expense of returns over the long term.

Periodic advantages and higher transaction costs

Of course, there are always periods when an equally weighted index outperforms its market-weighted counterpart. This is the case, when the stock prices of leading large corporations correct, while small or medium-sized companies catch up. However, it is impossible to reliably predict when such a scenario will occur. Betting on it would amount to speculating against the broader market.

Another practical disadvantage of equally weighted ETFs is the ongoing need for rebalancing. The stock prices of individual companies move at different rates. Therefore, the fund must regularly rebalance its portfolio to maintain equal weighting. This incurs transaction costs and taxes within the fund – so-called friction costs. Finally, the annual management fees for equally weighted ETFs are generally higher than those for traditional variants, which investors should always keep in mind when selecting ETFs.

The True Wealth approach

Due to the long-term investment horizon and significantly lower costs, we at True Wealth consistently rely on market-weighted ETFs and index funds.

We offset the concentration risk of individual heavyweights by broadly diversifying portfolios across different global regions and various asset classes. We deliberately avoid speculating on smaller companies relative to the broader market.

What are your thoughts on equally weighted ETFs? Do you already have such products in your portfolio, or do you prefer traditional market-weighted indices? Feel free to email me about your experiences.