Most of the stock indexes we see atop the headlines every day aren't simply the average of a large collection of stocks. The S&P 500, for example, is market capitalization-weighted, meaning that the movement of a company like Apple (NASDAQ: AAPL ) counts 8 times as much towards the index as does the movement of a company like Walgreen Company (NYSE: WAG ), a dominant and important company in its own right. And while that may be the most capitalistic way to look at the market, it's certainly not the most democratic.

The Dow Industrial Average is even weirder, using not market cap but stock price weighting, so that a stock that trades for $100 counts 4 times as much as a stock that trades for $25 regardless of the actual sizes of the two companies. For example, in today's DJIA, Visa Corp (NYSE: V ) is the largest single holding. at over 8%. Cisco Systems (NASDAQ: CSCO ) is the smallest holding, at less than 1%. The two companies, meanwhile, have market caps that are within 5% of each other.

Equal-Weight ETFs: Reasoned Alternatives for Investors

Because of (or maybe in spite of) this fact, there have been many new ETFs hitting the market that employ an equal weighting method; every stock in the fund is assigned an equal percentage weighting. With equal weight ETFs, investors can put the same number of dollars into each stock in the fund. Most equal weight ETFs are rebalanced each quarter to account for the inevitable market cap fluctuations that occur in the year.

Today I've used Capital Cube's ETF screener to highlight some of these ETFs, with some important qualifiers of my own:

• Large cap stocks only; I believe the risk-adjusted value of equal weight ETFs drop when the market caps start to get small. Long-term investors should save their small-cap investments for targeted funds.
• Low expense ratio there are very few exceptions to my rule of thumb that no ETF should have an expense ratio greater than .75%; I'm filtering out anyone higher.
• Decent size I don't want to deal with the liquidity risk of a fund with meager assets under management. So only ETFs with at least $100 million are allowed.

I also wanted to screen for low volatility ETFs, so I filtered out anyone that had a 3 year annualized volatility higher than that of the largest S&P 500 tracking fund the S&P 500 ETF Trust (NYSE Arca:SPY ) at 16.46%.

Since we're screening a large group down to a small one, why not be greedy? Let's look for ETFs that have outperformed the 12% average return delivered by the S&P 500 over the past 3 years.

Quick Takeaways

Beating the S&P 500 with lower volatility is darn hard to do. There's good reason why it's the most important equity benchmark on the planet. So with that in mind, any ETFs that do indeed beat the S&P 500 on return and lower volatility are worthy of our attention, even if they have a sector focus.

The most obvious contender, the Guggenheim S&P 500 Equal Weight ETF (NYSE Arca: RSP ) has a slightly better return (12.29% to 11.95%) over the past 3 years, but the risk has been higher (18.23% volatility to 16.46%) than that of the SPY. Also, the dividend is 50 basis points (half a percent) lower on the RSP. because smaller companies tend to pay smaller yields than the mega-caps.

No surprise then, that if you go further up the mega-cap chain, up to the Dow Jones Industrial Average and its ETF tracker the SPDR Dow Jones Industrial Average (NYSE Arca:  DIA ), you'll see that it pays a higher dividend (2.1%) than both S&P variants; it also has a lower P/E at 15x. But that doesn't mean it's the safest ETF; the Dow's concentration around just 30 stocks can be dangerous, and the fore-mentioned price weighting is both silly and irresponsible. You have to know exactly what you're getting (lower valuations, higher dividends) and what you're giving up.

Guggenheim S&P 500 Equal Weight Healthcare ETF (NYSE Arca: RYH )

CapitalCube 's Screener results included equal weighted sector ETFs. The metrics for the Guggenheim S&P 500 Equal Weight Healthcare ETF (NYSE Arca: RYH ) include an impressive 16.86% average return over three years, and done with a volatility a hair lower than the S&P 500. RYH has a nice mix of exposure to pharmaceuticals, medical devices, biotech, and insurers. So despite all the hoopla around the ongoing changes to the healthcare system, this sector has delivered some of the best risk-adjusted returns around the past few years.

The only knock against the RYH is the low dividend yield of 0.46% a full point lower than another solid risk-adjusted return fund, the Guggenheim S&P 500 Equal Weight Consumer Staples ETF (NYSE Arca: RHS ).

Guggenheim S&P 500 Equal Weight Consumer Staples ETF (NYSE Arca: RHS )

The RHS returned an average 13.9% the past 3 years while it maintained an extremely low volatility of 13%. Capital Cube's advanced metrics tell us that nearly 75% of this ETF's holdings have fundamental scores above the average of their peers :

While I would recommend both of these ETFs, it's important to note that if you have base holdings of S&P index or mutual funds, you'll get overlap with these sector ETFs. Their best fit would be for investors who utilize individual sector funds already, and could swap these equal weight ETFs in for existing holdings. Likewise, if you want some overexposure to certain sectors in the base S&P 500, equal weighted sector funds are a great way to approach them.

Parting Thoughts

Broad indexes like the S&P 500 are the benchmark for nearly all of the single largest mutual funds and index funds out there. And for good reason; sector weightings closely resemble macroeconomic activity in this country and we want our core investments to model this. But equal weight ETFs make some strong arguments for their incorporation into a long-term portfolio.

The views and opinions expressed above are those of the author and do not necessarily reflect the views of  CapitalCube .com, AnalytixInsight, Inc. its affiliates, or its employees.