Equal Weight ETF

Countering the unintended flaws of traditional index investing

Just a small number of huge US companies now dominate stock market indexes, meaning that they no longer fulfil their original purpose. After all, an index is meant to represent the performance of the broad market. To overcome this flaw, equal weight etf has been developed that track equally weighted indexes.

VanEck Sustainable World Equal Weight UCITS ETF

Broad diversification: global universe, equal weight per stock, regions capped at 40%
Long-standing track record
Backed by ESG-intelligence from Moody’s
Main Risk Factors: Foreign currency risk, equity market risk, market risk

ETF Details

Basis-Ticker: TSWE
ISIN: NL0010408704

TER: 0.20%
AUM: €816.9 M (as of 10-12-2024)
SFDR Classification: Article 8

VanEck Sustainable European Equal Weight UCITS ETF

ESG-screened investing in line with the UN Global Compact Principles
Equally weighted, diversified exposure to European companies with a maximum weighting of 20% per country
Backed by sustainability intelligence from Moody’s
Main Risk Factors: Foreign currency risk, equity market risk, industry or sector concentration risk, risk of investing in smaller companies

ETF Details

Basis-Ticker: TEET
ISIN: NL0010731816

TER: 0.40%
AUM: €52.3 M (as of 10-12-2024)
SFDR Classification: Article 8

What’s an Equal Weight ETF?

It’s complicated but rooted in common sense. Traditionally, market capitalization-weighted indexes allocate to different stocks according to their shares’ respective capitalizations or values. Therefore, the index is skewed towards the biggest companies. By contrast, an equally weighted index gives every stock an equal weighting.

The concept of equally weighted indexes, and by extension equal weight ETF, has become topical because the big US tech stocks now account for such a big percentage of world stock markets.

Illustrating the problem, in mid-2024 the ‘magnificent seven’ US tech stocks made up a fifth of the MSCI World Index of international companies.¹

¹ Source: MSCI. As at 31 July 2024.

Advantages and Disadvantages of Equal Weight ETF

While equally weighted indexes and ETFs are truer to the original purpose of stock market indexes, it’s fair to say that as well as their benefits come at a small additional cost. Below is a summary of their advantages and disadvantages.

Advantages

A Better Balance of Risk
Exposure to Smaller Companies
Naturally Contrarian

Equally weighted indexes reduce the risk of concentrating on a few mega companies. Instead, they spread risk equally across a stock market, regardless of a company’s size. This means that the index is not unduly exposed to the fortunes of just a few giant businesses: for instance, moving up and down depending on the quarterly earnings announcements of the US tech companies developing generative artificial intelligence.

Treating each stock in the same way gives equally weighted indexes a higher allocation to small and mid-sized companies. This provides equally weighted indexes with greater exposure to the ‘small cap effect’ that suggests smaller company stocks should outperform over longer periods of time.² It also means they perform well in periods when smaller and mid-sized companies outperform for short periods of time (see periods of outperformance below).

² Fama-French model, developed in 1992.

Equally weighted indexes are inherently contrarian as they continually rebalance-buying low and selling high. This goes against herd behavior and momentum investing. In times of great investor optimism, or pessimism, equally weighted indexes may perform better because they are less influenced by sentiment-driven price movements in a few large stocks.

Disadvantages

The Costs of Rebalancing
Exposure to Smaller Stocks
Scalability Issues

Equally weighted indexes are periodically rebalanced to maintain equal weights. This involves selling shares of stocks that have increased in value and buying those that have decreased in value. This trading activity increases the transaction costs of an equal weight ETF.

Equally weighted strategies inherently give more weight to smaller-cap stocks than market-cap-weighted strategies. This can lead to higher volatility and risk, as smaller-cap stocks tend to be more volatile and less liquid.

Managing an equally weighted strategy becomes increasingly difficult with a larger number of securities. For large portfolios, achieving and maintaining equal weights can be operationally intensive and complex. While reweighting 50 or 250 stocks might be deemed unproblematic, doing the same for a broad benchmark of 1500 stocks might be an operational nightmare.

Periods of Outperformance

Historically, equally weighted indexes have outperformed in market periods such as recoveries from market crises and bull markets. These are times when small and mid-sized companies tend to outperform. Understanding when this has happened can provide an idea of when it might recur in future.

2003-2006: Bull Market
2009-2013: Recovery From the Global Financial Crisis
2020-2021: Recovery From COVID-19 Pandemic

This period of sustained US economic growth benefited smaller and mid-sized US companies, which are entrenched within the domestic economy. The equally weighted version of the S&P 500 index outperformed.

Bull Market Performance

Source: Bloomberg.

Following the GFC, the equally weighted version of the S&P 500 index once again outperformed. As stock markets recovered, it had a more diversified exposure to the full range of sectors, while the mainstream market capitalization weighted index was more exposed to financial stocks that took longer to recoup their losses.

Post GFC Recovery

Source: Bloomberg.

In the initial stage of the stock market’s recovery, small and mid-sized stocks bounced back fastest. Again, this underpinned an outperformance by equally weighted strategies.

Covid Recovery

Source: Bloomberg.

Focusing on the VanEck Sustainable World Equal Weight ETF

To understand how much of a difference an equal weighted ETF can make, it’s helpful to focus on the VanEck Sustainable World Equal Weight UCITS ETF.

The ETF tracks the Solactive Sustainable World Equity Index, which includes 250 stocks. According to the Herfindahl-Hirschman Index measure of equity market concentration, the ETF holds an ‘effective’ number: 246.³

Yet the MSCI World Index, the best-known global market capitalization weighted index, which includes 1,428 stocks has an ‘effective’ number of stocks amounting to just 104.

Actual Versus Effective Number of Stocks

Source: VanEck.

This can result in significant biases to different parts of the world that the investor may not intend. For instance, less than half of the ETF (40.1%) is invested in North America, but three quarters (74.5%) of the MSCI World Index is allocated to the region (see below for regional exposures).⁴

Source: Morningstar.

There are also substantial biases to individual sectors. For instance, more than a quarter (26.0%) of the MSCI World Index is allocated to the tech sector, compared with just a fifth of the ETF (20.1%).

Source: Morningstar.

In summary, traditional indexes are flawed in a world where just a few big companies’ stocks have market capitalizations that dominate equity markets. Equally weighted indexes are intended to overcome the problem.

³ Concentration data as at August 2024.

⁴ Weighting data as at August 2024.

Top 10 Holdings

Holding Name	Shares	% of Net Assets
Tesla Inc	18866	0.75
Xiaomi Corp	1701400	0.70
Argenx Se	8946	0.64
Recruit Holdings Co Ltd	74584	0.60
Nvidia Corp	36154	0.58
T-Mobile Us Inc	20108	0.58
Shopify Inc	41688	0.56
Booking Holdings Inc	922	0.56
3i Group Plc	100697	0.55
Fiserv Inc	20945	0.54
Top 10 Total (%)		6.05

View All Holdings

Key Documents and Links

KID

Prospectus

Fund page

Main Risk Factors of Equal Weight ETF

Exchange Rate Risk
Equity Market Risk
Liquidity Risk

The value of an investment in the Fund can be affected by exchange rate fluctuations. The price of the euro can rise against another currency in which an investment is denominated.

The value of the securities held by Equal Weight ETF may fall suddenly and unpredictably due to general market and economic conditions in markets in which issuers or securities held by the fund are active.

Liquidity risk exists when a particular financial instrument is difficult to purchase or sell. If the relevant market is illiquid, it may not be possible to initiate a transaction or liquidate a position at an advantageous or reasonable price, or at all.

Please contact us for more information:

VanEck Netherlands, Amsterdam
Phone: +31 (0)20 719 51 00
Email: nlinfo@vaneck.com