Top Investing Takeaway of 2018
As the year is coming to an end, you’ve by now likely seen several research papers, charts and heard prognostications about how to think about the year gone by and how to plan for next year. Threadvest would like to comment about some powerful points we came across and ask you to consider it on our year end takeaway. We are talking about the research from Aye Soe, Managing Director on S&P Dow Jones’ Global Research team. S&P research indicates that almost 100% of active large cap managers under-perform the equal weighted S&P 500 index over the course of 15 years. In other words, if you simply bought every stock in S&P 500 in equal amounts, you would have performed better than a fund that is actively looking for stocks in an effort to outperform the index. These active managers come in anywhere from reasonable on the cost side to expensive. But how many in any case accomplish what they intended to do?
The idea of active fund management is that with careful analysis and experienced staff the returns they provide you would be superior to investing in a predetermined index. One would expect this approach to outperform the predetermined indicies given that it generally costs more and uses professional stock pickers giving their full attention. S&P’s research notes that this has been accomplished at times in the shorter term. As we go further down the investment horizon, fewer active managers continue to beat their predetermined indicies or benchmarks. Who wants to be the king of the short-term?
Equal Weighted S&P 500 Index
We now enter the world of a predetermined index, as I mention above. An equal weighted S&P 500 index for example is different from the SPY ETF which is market capitalization weighted on the S&P 500. A market capitalization index adds more weight toward stocks that have a higher market caps such as Apple, Amazon, Google etc. That is not what an Equal Weighted S&P 500 index does. It is indifferent to the size of the company, and equally weights every company in the S&P. When the first equal weighted S&P 500 ETF came to being in 2003, the idea behind it was that market capitalization weighting inherently caused investors to be overweight pricier stocks (hence higher market capitalization). The assumption with equal weighting was that all stocks had the same risk and return at a given point in time, therefore it was not necessary to overweight your investment to any particular stocks.
S&P’s research finds that in the short term which is typically around 1 year, active management as described above outperformed an equal weighted S&P 500 strategy. However, around year 3, the majority of active management funds began under-performing, and by year 15, almost no active fund could outperform an equal weighted strategy. Also, only one in ten active funds was able to outperform the standard S&P 500 market capitalization weighted index. This is an astounding finding, hence the performance of the predetermined index reflected in equal weighting has to be Threadvest’s 2018 investing takeaway.
Using ETF Miner to search for equal weighted ETFs
In spite of what we feel is compelling research, there are arguments out there as to whether SPY (market cap ETF) is better than RSP (equal weighted ETF) and vice versa. Threadvest is not trying to join that debate and get into ETF comparisons, rather than to indicate that both are a viable long term strategies over active management. Threadvest’s ETF Miner web based search architecture is created for investors to look for ETFs in a simple and streamlined manner. For example, if one selects the “Equal Weighted Size” category, sorted out your priorities and chose growth as the purpose of the investment, three ETFs would be raised for your consideration:
The three ETFs we get above are all interesting choices, from equal weighted to those with a twist. RSP represents all of the stocks in the S&P 500, equally weighted. SIZE is weighted with additional allocations towards companies that have smaller market caps. Since it is not as simple as RSP, you should take a look if you prefer that particular twist. EQAL is an equally weighted ETF with the Russell 1000 stocks index which as the number implies, has a broader focus than the S&P 500.
Given that we discussed the favorable returns with the simple equal weighting strategy earlier in this article, we choose to focus on RSP. RSP is Invesco’s ETF with almost $14 billion under management. It has been around since 2003. RSP was one of the ETFs Invesco acquired from Guggenheim Investments earlier in 2018, hence at some online data providers you might see RSP still carry Guggenheim’s name. Since inception, RSP has returned 11.37% a year versus S&P 500 index which is at 10.05%. That is a 1.32% difference a year, is significant by financial performance standards and given most S&P index funds outperformed active management that difference magnifies when compared to active.
Lastly, see below the growth of $10,000 invested 10 years ago in the RSP ETF. Currently the value of RSP, bought 10 years ago for $10,000 would be worth approximately $32,815. Not bad.