This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Rebalancing Your ETF Portfolio, Part 1

Stocks in this article: SPY IVV IWM

Investors who are happy with the benchmark's index returns minus the expense ratio of the ETF tend to stick with market-cap weighted ETFs and attempt to add alpha through overweighting growth or value around the benchmark, according to their market prognostications.

How do market-cap weighted ETFs such as the S&P 500 Index SPDR (SPY), iShares S&P 500 Index (IVV), iShares Russell 2000 (IWM) and Vanguard Large-Cap ETF (VV) rebalance?

Well, the short answer is they don't rebalance, as there is no pre-defined rebalancing schedule within the market-cap methodology. Unfortunately, if one's motivation is to outperform his or her benchmark, using market-cap-weighted ETFs requires precise timing on when to be long the market and when to be in cash because simply buying and holding a market-cap-weighted ETF will lose to the benchmark 100% of the time due to the expense ratios associated with holding the ETFs. In essence, market-cap-weighted ETFs are rebalanced by the market's fluctuations in price, and as one university endowment manager once aptly stated to me, "they rebalance by attrition" which is certainly food for thought.

Rydex competes with the market-cap-weighted ETFs with S&P 500 Equal Weight ETF (RSP). The underlying constituents are the exact same 500 names that are in SPY and IVV, but this ETF actively rebalances the portfolio holdings, as the market pushes them out of line. Unlike SPY or IVV, in which market forces drive the individual weightings of the securities up or down within the ETFs, RSP will rebalance the underlying index on a quarterly basis to keep all 500 members with equal weightings.

In between the quarterly rebalances, of course, RSP functions just like a free-float market-cap index, and certain names or sectors may surge while others fall, thus changing the weightings from top to bottom within the ETF between rebalance periods. Why rebalance quarterly and why equal-weight your index? If you examine the five-year trailing returns of SPY, IVV and RSP, you will see RSP truly has added alpha against the benchmark, up 2.49%, with SPY down 8.80% and IVV down 8.65% during this period. The five-year performance can be seen here.

So it seems that a regular rebalance like the RSP employs adds value, but it certainly doesn't come without cost. RSP charges 40 basis points, while SPY and IVV charge 9 basis points. I urge portfolio managers not to judge the quality of an ETF by cost alone. Instead, assess whether the ETF is designed to and has demonstrated the ability to outperform its stated benchmark. If it has, then simply factor in the expense ratio to net out this outperformance, and if you are still ahead of your benchmark, then the ETF is certainly worth further examination and consideration for your portfolios.

Paul Weisbruch is the VP of ETF/Index Sales/Trading at Street One Financial, graduating from the University of Pittsburgh, with an MBA from Villanova University. Before Street One, Paul was Director of Institutional ETF Sales at RevenueShares ETFs from December 2007 until November of 2009. Before RevenueShares, Paul was employed by Susquehanna International Group from 2000 until 2007, serving in roles including ETF Floor Specialist on the PHLX, ETF/Derivatives Intelligence, and Algorithmic Trading. Paul has been quoted in ETF industry publications including Morningstar, Traders Magazine, and Index Universe. He holds his Series 4, 6, 7, 55, 63, and 65 licenses.
2 of 2

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!

Markets

DOW 17,804.80 +26.65 0.15%
S&P 500 2,070.65 +9.42 0.46%
NASDAQ 4,765.38 +16.9840 0.36%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs