RSP - GSEW: Is Equal-Weight Really Worth It?

2023-11-24 02:12:29 ET

Summary

• Goldman Sachs Equal Weight U.S. Large Cap Equity ETF is a competitor to Invesco S&P 500 Equal Weight ETF with cheaper fees and a monthly rebalancing.
• A more frequent rebalancing may be an edge in certain market conditions, but a drag in other ones.
• An equal-weight methodology may be a good choice in some sectors, but in 20 years, it has brought negligible excess return and higher volatility in the S&P 500 universe.

GSEW strategy and portfolio

Goldman Sachs Equal Weight U.S. Large Cap Equity ETF (GSEW) is a passively managed fund tracking the Solactive US Large Cap Equal Weight Index. It started investing operations on 9/12/2017, has 498 holdings, a trailing 12-month distribution yield of 1.82% and an expense ratio of 0.09%. Distributions are paid quarterly. It is almost exclusively invested in US companies (99% of asset value).

Equal weight indexes have a few advantages:

• A better diversification, therefore, a lower risk related to mega-cap companies.
• A positive bias regarding Fama-French's size factor , by giving a higher weight to smaller companies.
• An implicit "buy low - sell high" trading pattern embedded in the rebalancing process.

They also have drawbacks:

• A higher turnover rate, resulting in transaction costs and less favorable tax treatment.
• A higher volatility in market downturns because smaller, more volatile companies have a higher aggregate weight.

The closest competitor is Invesco S&P 500® Equal Weight ETF (RSP), which is also focused on large cap companies and has a similar number of constituents. The table below compares some of their characteristics.

GSEW has a lower expense ratio despite a more frequent rebalancing, but it is also a smaller fund with much less liquidity.

Even if the underlying indexes are different, they share most of their holdings. In fact, the Solactive US Large Cap Equal Weight Index has exactly the same constituents as the S&P 500 (SPY) as of writing. I put the ticker lists in alphabetical order side by side on 11/23/2013. There was no difference.

RSP holds all of them and GSEW ignores a few, likely among the less liquid ones, which are more costly to rebalance. The main difference between the two funds is the rebalancing period: monthly for GSEW, quarterly for RSP.

As plotted on the next chart, they are very close regarding the sector breakdown, and they are more balanced than the S&P 500. Compared to the capital-weighted benchmark, they massively underweight technology and communication. They overweight mostly industrials, real estate, utilities and materials.

They also are very close in valuation, and significantly cheaper than the S&P 500 index, as reported in the next table.

Source: Fidelity

Looking at the top holdings is not really useful, as all constituents are rebalanced in equal weight quite often.

Performance

Since inception, GSEW has underperformed the S&P 500 by about 3% in annualized return. It is close behind RSP: the difference is just 40 bps. Drawdowns and volatility, measured as standard deviation of monthly returns, are similar for the equal-weight funds, and show a significantly higher risk than for the capital-weighted benchmark.

Data calculated with Portfolio123

However, GSEW has outperformed RSP in 2023 to date, and both lag SPY by a wide margin.

On the longer term, the equal-weight methodology has brought a small excess return since RSP inception (04/24/2003), as reported in the next table. Nevertheless, the 20-year risk-adjusted performance (measured by Sharpe ratio) stays inferior to the benchmark .

Takeaway

Goldman Sachs Equal Weight U.S. Large Cap Equity ETF is a direct competitor to Invesco S&P 500 Equal Weight ETF. Their underlying indexes may be different in their definitions, but they currently have identical constituent lists. GSEW is newer, has cheaper fees, and a lower liquidity. It features a monthly rebalancing, whereas RSP is rebalanced quarterly. A more frequent rebalancing may be an edge in certain market conditions (like in 2023), but an inconvenient in other ones (2017-2022). For long-term investors, these funds are equivalents. Obviously, higher trading volumes make RSP a better choice for short-term trading and tactical allocation. The true question is if an equal-weight methodology is really better than a capital-weighted index. Intuitively, it looks less risky because of a better diversification, and it should profit from the size factor and rebalancing process. However, it incurs additional trading costs, a less favorable tax treatment, and it gives a higher weight to the most volatile stocks. Equal-weight ETFs may be a good choice as sector ETFs, especially when the capital-weighted index is massively overweight in one or two holdings. However, in the US large cap universe, 20 years of data point to a small excess return (about 0.6% annualized) and a higher volatility, resulting in a marginally lower risk-adjusted performance.

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