More ETFs Are Taking Equal-Weight Approach

XShares Advisors recently launched a set of REIT ETFs that are equal-weighted. The most wide ranging is Adelante Shares RE Classics (NYSEArca: - ). Other firms such as Rydex have also done so in recent years, as with Rydex S&P Equal Weight (AMEX: - ), rolled out in 2003.

Cap weighting is traditional for indexes such as the Standard & Poor's 500. Most ETFs still weight their stocks this way.

With equal weighting, a 1% rise or fall in one security's price has the same impact on the index's performance as another. Not so in cap-weighted indexes. In the Nasdaq composite, Microsoft's (NasdaqGS: - ) 5.5% weighting dwarfs No. 48 Wynn Resorts' (NasdaqGS: - ) 0.3%.

Not all stocks perform equally, so periodic rebalancing is needed to put the weights back in sync.

Taming The Big Names

Bryan Richards, an ETF analyst at XShares, says the firm wanted to offer exposure to a broad range of REITs without overconcentrating in a few big names.

"Usually, you end up putting something like 50% of your portfolio in the same 10 or so stocks," he said.

Simon Property Group's (NYSE: - ) market cap is $23.8 billion, way above IBD's Finance-REIT group's average $2.29 billion.

Equal weighting is aimed at reducing the impact of the biggest stocks. Their heft magnifies the effects of bubbles.

XShares' other ETFs are also equal-weighted, including a series in health care.

Despite the woes of the subprime sector, Richards says REIT ETFs have little exposure to it. Most of the stocks are companies that deal in commercial real estate, which was unscathed by the mortgage mess.

In addition, much of the turmoil has already been priced into the stocks, he says. IBD's Finance-REIT group has climbed 20% from its mid-August bottom, though it remains 16% below its 52-week high.

Performance Mixed

It is not clear whether equal weighting provides better performance over time.

Rydex S&P Equal Weight holds the same stocks as the S&P 500 and rebalances quarterly. Its three-year return is 14.89%, or 1.07 percentage points above the S&P 500's.

Its one-year return of 15.77% and year-to-date return of 9.70% trailed the S&P by about 2.33 and 2.23 percentage points respectively.

Equal-weighted indexes are more likely to outperform when small stocks do better than larger ones. That's because small-stock performance counts as much as big caps'. When large-cap stocks outperform, then the equal-weight ETFs could be expected to lag.

Ed Lopez, director of ETF strategies at Rydex, says equal weighting appears to work better for investors that want single-sector exposure.