Invesco PowerShares Capital Management LLC today had a coming out party for the PowerShares Russell 1000 Equal Weight Portfolio (EQAL) exchange-traded fund, a product that actually began trading on December 23.
The fund, which tracks the Russell 1000 Equal Weight Index, joins PowerShares’ existing roster of alternatively weighted, or so-called smart-beta ETFs that includes 64 equity products and nine fixed-income offerings. Smart beta-type products are a broad category based on indexes that aren’t market capitalization-weighted.
Equal-weighting is the simplest form of smart-beta. The Russell 1000 Equal Weight Index first equal-weights each of the nine sectors within the index, and then equal weights the constituents in each sector. After every quarterly rebalancing, each sector represents 11 percent of the index, plus change. Or, to put it another way, the top three sectors––or any three sectors for that matter––add up to 33 percent of the portfolio.
Ken O’Keeffe, managing director of investable products at Russell Investments, says market cap-weighting the Russell 1000 leads to the top three sectors comprising 48 percent of the index. And equal-weighting the Russell 1000 by its constituents––and not first equal-weighting the sectors––leads to the top three sectors representing 52 percent of the index.
O’Keeffe says the methodology behind the Russell 1000 Equal Weight Index provides investors with greater diversification.
Along with increased diversification within the index, equal-weighting by sectors potentially might generate excess returns, too. According to Russell Investments, over the 10-year period ending December 31 the average annualized returns on the Russell 1000 Equal Weight index was 11.31 percent versus annualized gains of 7.96 percent for the Russell 1000 index.
But as the old saw cautions, past returns don’t guarantee future results. And some folks question whether the outperformance shown by the equal-weighted methodology––whether based on individual constituents or sectors––is driven by higher exposure to the small-cap factor and thus is simply a result of taking greater risk.
Nonetheless, equal-weighting is gaining popularity. So much, in fact, that the PowerShares EQAL fund is the second product on the market that tracks the Russell 1000 Equal Weight Index. That other fund, the Guggenheim Russell 1000 Equal Weight ETF (EWRI), began trading in December 2010 and has accumulated nearly $50 million in assets while generating more than 15 percent average annualized returns since inception, according to Scottrade.
The difference between the funds mainly boils down to price––the Guggenheim fund’s expense ratio of 40 basis points is double that of the PowerShares fund.
And, on the surface, there’s also a difference in how the two funds report their sector allocations.