NEW YORK (TheStreet) -- In the sliced-and-diced world of exchange traded funds, there's been a genuine breakthrough: the ALPS Equal Sector Weight ETF (EQL) - Get Alps Equal Sector Weight ETF Report. The fund is an ETF that holds the nine Select Sector SPDRs in equal parts at 11.1%, subject to a quarterly rebalancing.
For anyone unfamiliar with the Select Sector SPDRs, State Street in 1993 created the
S&P 500 SPDR
and followed it up with funds for nine of the 10 biggest sectors. (Tech and telecom are combined in one fund.)
The ALPS Equal Sector Weight ETF does away with the stock market's natural weighting of the sectors. (If one industry does well, it tends to gain a bigger weighting in the S&P 500.) That differs from the
Rydex S&P Equal Weight
, which targets the same 0.2% weight for each of the index's 500 stocks.
The biggest benefit of the ALPS fund is that holders may be underweight in the next sector to take down the equity market. Before the tech bubble popped in 2000, that industry had grown to represent 30% of the index. At the peak of the financial bubble (the peak in prices of financial stocks), that sector accounted for 23% of the S&P 500. At their respective lows, each of those industries had fallen by more than half. Equal weighting of the sectors would have resulted in less exposure to the "wrong" stocks, sparing investors from the brunt of market crashes.
The fund's fact sheet shows that from Dec. 31, 1998, investors would have been better off by equal-weighting sectors. The back test benefits from being, at various times, underweight in technology, overweight in energy and underweight in financials. In periods of poor equity performance, equal weighting seems likely to outperform.
However, the period studied in the back test was one of three 10- to 15-year periods in which equities lagged behind historical norms. The past decade has, hopefully, been an anomaly. Hot sectors stay hot for long periods, usually growing past 11.1% of the S&P 500. As a result, investors who believe they can ride these trends and be disciplined to know when to cut back may want to avoid this fund.
The question of whether to buy the fund as a proxy for the U.S. stock market depends on where you think market leaders will come from. In looking at the current sector weightings of the market-cap version of the index, technology is the largest industry at 18.4%, followed by financials at 14.8%. Those sectors historically do relatively well during bull markets. Both industries would be underweight in the Equal Sector Weight ETF.
If, on the other hand, materials and utilities provide leadership, the Equal Sector Weight ETF will outperform. I wouldn't be comfortable blindly relying on a back test that occurred during a time that was particularly favorable for the fund's methodology. Choosing any alternative weighting, including equal-sector weights, over traditional market-cap weighting requires a look under the hood, assessing the makeup and choosing which is better for the current environment.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
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