Index Funds That Can Beat the S&P 500

"The rebalancing is probably an important contributor to the strong performance of the equal-weighted index," says Srikant Dash, head of global research for S&P.

Unlike the equal-weight index, the better-known S&P 500 sells cheap stocks and buys expensive ones. This occurs because the famous S&P benchmark uses market-cap weighting, putting more assets in big stocks than in small ones. The largest stock in the S&P is Exxon Mobil(XOM Quote), with 3.91% of assets, while a small stock can account for 0.01%.

The danger of market-cap weighting became apparent in the late 1990s when large technology stocks skyrocketed. As prices of Cisco Systems(CSCO Quote) and Microsoft(MSFT Quote) soared, the S&P 500 had to shift its holdings, cutting unloved stocks and keeping more shares of the technology stars. When the big names collapsed, the index fell hard. The equal-weight index also dropped -- but not as far as the S&P 500 did. The unloved stocks proved relatively resilient in the downturn and cushioned the equal-weight index.

To own the biggest blue chips in an equal-weight fund, consider (BRLIX Quote)Bridgeway Blue-Chip 35, which has returned 3.01% during the past decade, outdoing the S&P 500 by a fraction of a point. Bridgeway uses a proprietary selection process that generally includes the 35 stocks with the largest market capitalizations. However, there are some instances when the biggest stocks aren't picked for the fund. Bridgeway avoids tobacco stocks. In addition, the portfolio managers maintain diversification. So if too many energy or technology names are among the top 35 stocks, the proprietary system picks some of the next biggest companies to assemble a diversified group.