Market-cap weighted indexes dominate the ETF realm. Funds such as SPDR S&P 500 (SPY) attract investors by allocating assets according to a company’s market value. This eliminates the need for rebalancing and keeps costs low. Only when a company is added or removed from the index is rebalancing necessary, resulting in a very low-cost strategy that enables many large fund providers to offer large-cap market-weighted funds for less than 0.10 percent in annual management fees.
There are some drawbacks to market capitalization weighting as well. Weighting by market cap leads investors to own the most overvalued stocks in an index, and these stocks are hit hardest in the event of a correction or bear market.
Fund companies have created many alternative strategies to meet investor demand, ranging from simple to highly complex. Among the simplest funds are those that take the S&P 500 Index, or a substantially similar universe of stocks, and tweak the weighting methodology. WisdomTree Large Cap Dividend (DLN) uses dividends to weight holdings, while SPDR S&P Dividend (SDY) uses yield. Oppenheimer Large Cap Revenue (RWL; formerly RevenueShares) takes the S&P 500 and weights component companies by revenue. WisdomTree Earnings 500 (EPS) ranks companies by earnings. Guggenheim S&P 500 Equal Weight (RSP) fund utilizes the S&P 500 Index to weight holdings equally.
Sector and Market Cap Exposure
Two of the key factors affecting these alternative funds are their sector exposure and average market cap. Sector exposure can change over time, but most of these indexes tend to be relatively consistent. It’s a safe bet that five years from now the dividend-weighted funds will still be overweight utilities as compared with the S&P 500 Index.
As for specific sector exposure in each fund, with SPY for comparison: SPDR S&P 500 (SPY) counts technology, financials, healthcare, consumer discretionary and consumer staples as its top five holdings, with weightings ranging from 20.4 percent down to 10.5 percent in this group.
Guggenheim S&P 500 Equal Weight (RSP) weights financials at 17 percent of assets. Industrials are in the top five, while consumer staples are removed. RSP has more assets in utilities and materials, but not to a significant degree.
SPDR S&P Dividend (SDY) has 22.8 percent of assets in financials, followed by 16.3 percent in industrials, 14.5 percent in utilities, 12.3 percent in consumer staples and 10.6 percent in materials. Technology and healthcare are significantly underweight. Utilities is the major standout, and the fund tends to perform strongest, relative to the S&P 500 Index, when markets are underperforming.
WisdomTree Large Cap Dividend (DLN) is the most balanced of these funds, with only 15.4 percent in its largest sector, consumer staples. The fund does have 11 percent in energy, making it the most highly exposed of the group. Since the fund is balanced, the impact isn’t too pronounced, but DLN does tend to out- and underperform alongside the energy sector.
WisdomTree Earnings 500 (EPS) is the most similar to SPY in terms of sector weightings. Financials are 21.3 percent of assets, but technology is close behind at 19.3 percent.
Oppenheimer Large Cap Revenue (RWL) has 21.3 percent of assets in consumer discretionary and 20.6 percent in consumer staples, currently heavily weighted in consumer sectors. Since RWL uses revenue to weight holdings, however, weightings can change substantially over time, sometimes in as little as one year. Financials tumbled in 2008, as did energy firms in 2015.
Market-cap exposure is important in both the short and the long term. The equally weighted RSP is barely within Morningstar’s Large-Cap Blend category and almost falls into the mid-cap category as every holding in the fund gets a 0.20 percent weighting. SPY devotes more assets to larger companies given its strategy of market-cap weighting. It has 3.2 percent of assets in Apple (AAPL), 16 times the weighting of AAPL in RSP. As a result, SPY almost falls in the Mega-Cap Blend category. DLN, SDY and RWL all fall in the Large-Cap Value category, but SDY leans toward mid-caps. EPS is the most similar to SPY, falling in the Large-Cap Blend category.
Performance
Long-Term Performance since 2009
Since the market bottomed in March 2009, SPY went on to gain 225 percent through the end of February 2016. All but one alternative fund discussed here outperformed: EPS, which gained only 214 percent. The other funds ranged from a low of 229 percent for DLN to a high of 291 percent for RSP.
Performance in 2015
Last year was tough for value stocks and mid-caps. All five alternatives were beaten by SPY, which gained 0.2 percent. Losses ranged from 3.6 percent for RWL up to a loss of 1.9 percent for SDY.
Performance in 2016
In the first two months of 2016, SPY lost 5.06 percent. All but one of the five alternatives beat it: EPS fell 5.38 percent. RWL was the worst outperformer, down 4.72 percent, while SDY gained 1.07 percent and was the only fund in the black.
Owing to its lower average market capitalization, RSP behaves more like a mid-cap fund relative to the S&P 500 Index. Investors who expect mid-caps to outperform should consider RSP as an alternative to SPY.
DLN was hurt by energy exposure over the past 18 months, while SDY was significantly impacted by the utilities sector. Only EPS fails the performance test.
Income
DLN’s 2.88 percent yield is the most attractive to income investors. SDY yields 2.51 percent, while the S&P 500 Index presently yields 2.06 percent. The other three funds yield less than 2 percent.
Volatility
Volatility is an important consideration. A less volatile portfolio offers peace of mind and can increase long-term returns if a portfolio sees periodic withdrawals.
SPY has a beta of 1.00 versus the S&P 500 Index and a standard deviation of 10.93. RSP has a beta of 1.00 and a standard deviation of 11.17, and SDY has a beta of 0.86 and a standard deviation of 10.43. RSP is less volatile than SPY and, of the five funds discussed, the least correlated with SPY. DLN has a beta of 0.91 and a standard deviation of 10.28. RWL has a beta of 0.99 and a standard deviation of 11.06. EPS has a beta of 1.02 and a standard deviation of 11.22, the most volatile of the five.
Expenses
At 0.09 percent, SPY is one of the cheapest ETFs in the market. SDY’s 0.35 percent charge is much heftier, while DLN and EPS hold expenses lower at 0.28 percent. RSP charges 0.40 percent and RWL charges 0.49 percent as both require considerable rebalancing each quarter.
Conclusion
Of the five alternatives covered in this article, three are worth considering: RSP, SDY and DLN. Although the approach used by RWL is compelling, its higher fees, lower yield and relatively low average volume make it unattractive. EPS performed poorly and has a lower yield than SPY, and volume is much too low to make it a viable option.
Existing holdings should be taken into consideration when assessing the suitability of each fund to individual portfolios. RSP may balance portfolios with less exposure to mid- and small-caps. For those with hefty mid- and small-cap exposure, one of the large-cap options is more appropriate.
SDY is heavily influenced by utilities. Investors already tapping the utilities sector as a defensive or income holding may want to pass on SDY, depending on the level of exposure. However, it isn’t excessively overweight utilities, with financials and industrials leading exposure.
DLN has relatively high energy exposure, which has been a burden over the past 18 months. Investors who prefer higher dividends and who don’t mind a potentially extended period of underperformance should energy retest or break its lows can opt for DLN.