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

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.

A better alternative?
Interestingly, because equal-weight S&P 500 funds take away the vast majority of the weighting from the component stocks with the largest market caps, they tend to perform in line with mid-cap funds that only include stocks of similar size to the smallest stocks in the S&P 500. In fact, if you look at the returns for the S&P Mid-Cap 400 ETF over the same 10- to 15-year time frame, you’ll find that it outperforms the S&P 500 by an even larger margin than equal-weight funds. Yet as a Zacks report cited in Barron’s noted recently, you’ll end up paying a lot more in expenses for the typical equal-weight fund.

Why that is is a completely mystery. There couldn’t be anything easier than buying equal amounts of 500 different stocks, yet for some reason, equal-weight ETFs charge four to eight times what you’ll pay for the cheapest S&P 500-tracking index ETFs. Yet until a low-priced ETF provider comes out with an equal-weight option, you’ll be better off sticking with a mix of cheaper ETFs, with one covering large caps and others covering mid-cap and small-cap stocks.

Keeping your eyes on the prize
Despite their long-term outperformance, equal-weight ETFs are subject to the same cycles that dominate financial markets generally. They move in and out of favor compared to market-cap-weighted ETFs, sometimes outperforming, sometimes underperforming. Apple Inc. (NASDAQ:AAPL)s influence has helped equal-weight ETFs lately, but that’s not cause to abandon market-cap weighting entirely. No matter what ETF you pick, the key is for it to give you the stock exposure you want at a reasonably low price.

The article The Lure of Apple-Light ETFs originally appeared on Fool.com and is written by Dan Caplinger.

Fool contributor Dan Caplinger owns shares of Apple. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

10 Top Reasons For Getting Fired

The 3 Best States to Start an LLC

10 Jobs That Allow You to Travel

7 High-Paying Jobs You Can Do From Home

12 Best Cities to Shop in USA

10 Best States To Practice Medicine

The 10 Best States to Have a Business

The 12 Most Expensive Apple (AAPL) Apps in the Market

The 10 Richest Billionaires in the World

10 Biggest Kickstarter Failures

The 10 Best Places to Work At

The Top 10 of Google Inc (GOOGL)’s Most Expensive Acquisitions

13 Best Cities to Visit in South America

10 Most Expensive Works of Art of All Time

The 10 Richest Banks in the World

The 10 Best-Paying Jobs in America (2014)

7 Most Expensive Foods in the World

The World’s Top 10 Earning Authors

Five Wicked and Very Expensive Items (and Other “Stuff”) Sold on eBay

10 Biggest Celebrity Bankruptcies

The Top 10 Highest Paid CEOs in 2014

The 10 Most Expensive Real Estate Cities in America

10 Most Expensive States To Live In America

The 10 Best Airlines in the World

The 10 Best-Selling Cars in 2014

The 10 Best Industries to Invest In

The 10 Most Expensive States to Own a Car In

Top 10 Business Schools in US: 2014 Rankings

Top 20 Female Billionaires in 2014

6 Movies That You Should Watch to Better Understand The Cold War

Top 15 Best Paying Jobs for Women in 2014

Top 6 Things Rich People Do Differently Every Day

5 Retirement Mistakes To Avoid (and Einstein’s Famous Quote)

11 Smartest People in the World

6 Films About the Financial World You Need To Watch (While “The Wolf” is Not Around)

Warren Buffett and Billionaires Are Crazy About These 7 Stocks

The Top 10 States With Fastest Internet Speeds

10 Best Places to Visit in USA in August

Top 10 Cities to Visit Before You Die

Top 10 Genetically Modified Food In the US

15 Highest Grossing Movies Opening Weekend

5 Best Poker Books For Beginners

10 Strategies Hedge Funds Use to Make Huge Returns

Top 10 Fast Food Franchises to Buy

10 Best Places to Visit in Canada

Best Summer Jobs for Teachers

10 Youngest Hedge Fund Billionaires

Top 10 One Hit Wonders of the 90s

Fastest Growing Cities In America

Top 10 U.S. Cities for Freelancers

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!