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S&P Fund Tops the S&P 500

NEW YORK ( TheStreet ) -- Long-term shareholders of S&P 500 funds have reason to be satisfied. During the past 10 years, SPDR S&P 500 ETF (SPY) returned 7.8% annually. But investors could have gotten richer results with Guggenheim S&P 500 Equal Weight (RSP), which returned 10.6% annually.

As the name suggests, Guggenheim puts an equal amount of assets in each of the 500 stocks. Can the equal-weight fund top the traditional S&P 500 during the next decade? Probably. Under a variety of market conditions, the equal-weight fund has some key advantages over standard competitors.

Like most benchmarks, the traditional S&P 500 is weighted by market capitalization. So a stock with the greatest market value carries the heaviest weight. Exxon Mobil (XOM), the biggest stock in the benchmark, accounts for 2.8% of the assets in an S&P 500 index fund. The smallest holdings, such as Big Lots (BIG), account for 0.01%.

Many academics have long argued that market-cap weighting is the most efficient way to operate index funds. But there are notable problems with traditional benchmarks. When markets become overheated, the most popular stocks can account for an outsized percentage of assets. That exposes investors to significant risks.

During the Internet bubble, the technology component of the S&P 500 soared from 13% of assets in 1998 to 33% in March 2000. A handful of mega-cap names -- including Microsoft (MSFT) and Cisco Systems (CSCO) -- accounted for a sizable percentage of assets. When technology crashed, investors in index funds suffered painful losses.

To avoid placing big bets on individual stocks and sectors, more investors have begun gravitating to equal-weight benchmarks. The Guggenheim fund puts 0.20% of assets in each of the S&P 500 stocks. Every quarter, the portfolio rebalances, selling off appreciated shares to bring weightings back in line. The value of steering away from hot shares became clear when the Internet bubble burst in 2000. For the year, the S&P 500 lost 9.1%, while the S&P 500 equal-weight benchmark gained 9.6%.

Because it does not overweight the biggest shares, Guggenheim has a greater emphasis on the smaller stocks in the S&P 500. Many studies have shown that smaller stocks outdo larger ones over the long-term. In recent decades, the mega caps have trailed smaller names, providing a big edge for the equal-weight approach.

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