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The Lure of Apple Inc. (AAPL)-Light ETFs

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The terrible performance of Apple Inc. (NASDAQ:AAPL) over the past six months hasn’t just hurt its shareholders. Just about anyone who invests in any sort of index fund has felt the pain of Apple’s 40% correction, given the tech giant’s status as the biggest company in the U.S. stock market.

Apple Inc. (AAPL)

When one stock can have such a huge impact on what’s supposed to be a diversified investment vehicle, it’s tempting to conclude that there’s something flawed about that investment’s methodology. Apple’s losses are a big part of the reason that investors are taking a close look at equal-weight ETFs to see if they can deliver better returns with less risk.

Hitting the big ETFs
It’s not hard to find proof of just how damaging Apple’s plunge has been. The popular PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ), which tracks the Nasdaq 100 index, has fallen 1.3% in the past six months since Apple Inc. (NASDAQ:AAPL) hit its all-time high above $700 per share. That compares to an 8% gain for the S&P 500 — despite Apple’s sizable weighting in that index — and a similar gain of 7% for the Apple-free Dow Jones Industrials excluding dividends.

You can see another sign of the massive hit that Apple Inc. (NASDAQ:AAPL) has had on the index by looking at the Direxion Nasdaq-100 Equal-Weight ETF, which has gained more than 9% since last September. In that ETF, Apple has only a 1% weighting rather than the 13% weight that the tech giant has in the PowerShares ETF.

Proponents of equal-weight funds argue that this proves the validity of their strategy. Rather than taking market capitalization into account in buying more of some stocks than others, equal-weight funds simply buy equal amounts of every stock in an index. The result is a truly diversified portfolio that gets rebalanced regularly to incorporate changes in share price.

Over the long haul, the equal-weight strategy has worked very well. Given the relative outperformance of smaller, more volatile stocks compared to their larger counterparts, equal-weight funds have benefited from having greater weight on smaller stocks and less exposure to lagging blue chips. Although ETFs using the strategy have relatively short histories, similar equal-weight traditional mutual funds have histories going back 10 to 15 years, and they’ve tended to outperform the market-cap-weighted S&P 500 by 2 to 3 percentage points annually — a huge amount to see year in and year out.

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