S&P 500 Market Cap or Equal Weighted?
When we talk about the S&P 500, we often refer to the SPY ETF, which represents the 500 largest U.S. companies by market capitalization. In this ETF, the companies are weighted according to their market cap. However, the current S&P 500 is heavily concentrated, with companies like NVIDIA, Apple, Meta, and Microsoft holding record weightings. This concentration potentially reduces the diversification benefits of owning 500 companies. To address this, many investors turn to the equal-weighted version of the S&P 500 (RSP ETF), where each company has the same weighting. At Alpha Rho Technologies LLC, we conducted a comprehensive analysis of the historical performance of both strategies using their respective ETFs.
Here are the main takeaways:
- Returns: On average, the equal-weighted version outperforms the market cap version, with annual returns of 11% compared to 10%. However, this excess return comes with higher volatility—18% for the equal-weighted version versus 15% for the market cap-weighted version.
- Risk: The maximum drawdown for the equal-weighted ETF is slightly deeper (-59% vs. -55%), but it recovers significantly faster—1,300 days versus 1,773 days for the market cap version.
- Risk-Reward: When adjusting for risk, the equal-weighted strategy generates an average annual alpha of -0.89%, indicating that the market cap-weighted version generally provides better risk-adjusted performance.
Why Not Own Both?
Our efficient frontier analysis suggests that a portfolio combining both strategies can reduce risk and improve returns. Historically, the optimal mix has been 16% in the S&P 500 Equal Weight (RSP ETF) and 84% in the S&P 500 Market Cap Weighted (SPY ETF), maximizing returns while lowering overall volatility.
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Disclaimer:
This is NOT investment advice, the content here is for informational purposes ONLY.