2023-06-07 05:11:12 ET
Summary
- The EQL ETF provides equal-weight exposure to the large-cap sectors via Select Sector SPDR ETFs.
- Over the long run, the EQL ETF has underperformed market ETFs like the SPDR S&P 500 Trust ETF.
- With the invention of fractional shares, investors can simply replicate EQL's strategy of holding quarterly rebalanced SPDR ETFs and save on the management fees.
The ALPS Equal Sector Weight ETF ( EQL ) provides equal proportionate weight to US large cap sectors via the Select Sector SPDR ETFs.
While the EQL ETF outperformed the market in 2022 with its overweight in energy and utilities, so far in 2023, it has underperformed. In fact, over the long run, the EQL ETF underperforms the markets.
Furthermore, I fail to see why investors need to pay ALPS 0.26% per annum (increasing to 0.47% in 2024) to buy and hold an equal weight basket of ETFs that are rebalanced quarterly. With the invention of fractional shares, investors of any size can easily replicate EQL's strategy if they so choose.
I would not recommend the EQL ETF to investors.
Fund Overview
The ALPS Equal Sector Weight ETF is a fund-of-fund ETF that provides exposure to U.S. large caps by investing equal proportions in 11 Select Sector SPDRs and rebalances the exposure quarterly.
The EQL ETF has $285 million in assets and charges a 0.47% operating expense ratio, although the manager has reduced actual expenses to 0.26% until March 31, 2024.
Portfolio Holdings
As designed, the EQL ETF simply holds the suite of Select Sector SPDR ETFs in equal proportion (Figure 1).
Equal Weight Vs. Market Weight Composition
The EQL ETF takes the view that contemporary market cap weighted indices and ETFs may not be optimal, as investors end up owning more of the largest companies in the index while they own relatively less of the smaller companies and sectors that may actually have better fundamental performance.
For example, the SPDR S&P 500 Trust ETF ( SPY ) is a market-cap weighted index with the largest companies commanding the largest weights. Figure 2 shows the sector weights of the SPY ETF.
Comparing Figure 1 and 2, we can see that relative to the 'market' as represented by the SPY ETF, the EQL ETF is very underweight Information Technology (10.0% vs. 27.8%). It also has modest underweights in Health Care (8.9% vs. 13.8%) Financials (9.1% vs. 12.5%), and Consumer Discretionary (9.6% vs. 10.3%).
The EQL ETF is conversely very overweight Real Estate (8.7% vs. 2.4%), Materials (8.9% vs. 2.5%), Utilities (8.4% vs 2.6%), Energy (8.9% vs. 4.2%) and Consumer Staples (8.8% vs. 6.8%).
Distribution & Yield
The EQL ETF pays a modest quarterly distribution with trailing 12 month distribution of $2.26 or 2.2% (Figure 3).
Equal Weight Outperformed In 2022
The EQL ETF has generally delivered strong historical returns, with 3/5/10Yr average annual returns of 12.9%/9.7%/10.4% respectively (Figure 4).
The EQL ETF actually outperformed the markets as represented by the SPY ETF in 2022, as the market heavy weight technology sector underperformed and defensive sectors like utilities outperformed. For 2022, EQL returned -10.6% vs. the SPY ETF which returned -18.1% (Figure 5).
But EQL Underperforms Over Longer-Term Timeframes
However, so far in 2023, the EQL ETF is once again lagging the SPY ETF, as the broad markets have enjoyed a strong rebound led by mega-cap technology stocks. YTD, the Technology Select Sector SPDR ETF ( XLK ) and the Communication Services Select Sector SPDR ETF ( XLC ) have returned 33.4% and 31.9% respectively, while other sectors are mostly down to flat (Figure 6).
Figure 6 - Select Sector SPDR ETFs YTD performance (sectorspdrs.com)
Furthermore, while the EQL ETF has performed well, its 5 and 10Yr average annual returns of 9.7% and 10.4% trail that of the SPY ETF, which has returned 10.9% and 11.9% respectively over the longer-term time frames.
Is EQL Really Equal Weight?
Another question that is worth discussing is whether the EQL ETF is really equal weight. While EQL's proportionate sector exposures are rebalanced quarterly, investors need to understand that the underlying ETF holdings, for example the XLK ETF, are themselves market-cap weighted funds (Figure 7).
Looking through EQL's portfolio structure, the EQL ETF has a 9.95% weight in the XLK ETF, which has a 24.5% weight in Microsoft and 22.9% weight in AAPL. This translates into a 2.4% and 2.3% weight respectively within EQL's portfolio.
So while investors may 'think' they are minimizing the effects of mega-cap companies by owning the EQL ETF, in reality, the mega-cap companies still exert more than 10x the weight of a true 'equal weighted' index.
Can Investors Replicate EQL With The Underlying ETFS?
Finally, EQL's strategy of buying the Select Sector SPDR ETFs in equal weight proportions rebalanced quarterly is actually extremely easy to replicate. Any investor with even the simplest of brokerage accounts can replicate EQL's strategy and save on the 'management' fees.
This is especially true in the current environment where investors can buy fractional shares of ETFs and stocks, so even the smallest of portfolios can replicate EQL's strategy.
While 0.26% per annum may seem like a small fee (note, this will increase to 0.47% in 2024), compounded over many years, this could translate into quite a difference in overall portfolio returns.
Conclusion
The EQL ETF provides equal proportionate weight to US large cap sectors via the Select Sector SPDR ETFs. While the EQL ETF outperformed the SPY ETF in 2022 due to its relative overweight in defensive sectors and underweight in the technology and communications sectors, over the long run, the EQL has underperformed the market cap weighted SPY ETF.
Furthermore, EQL's strategy is so simple that investors can replicate it with a quarterly rebalance of the underlying ETFs if they so choose, saving on management fees which are slated to increase in 2024.
I would not recommend the EQL ETF to investors.
For further details see:
EQL: Easily Replicable Strategy; Save The Management Fees And Avoid