In the investing world, not all exchange-traded funds (ETFs) are created equal. Quite literally, most aren’t. 

Most ETFs use a market capitalization weighting scheme to determine how much gets invested in each security. For simplicity, let’s say an equity fund is comprised of three stocks with the following market caps:

• stock A - $10 billion;
• stock B - $5 billion;
• stock C - $1 billion.

A market cap weighted ETF would invest proportionately. Stock A accounts for $10 billion of the $16 billion total market cap, so it would represent 62.5% of the ETF. Along the same lines, stocks B and C would get 31.25% and 6.25% weightings, respectively.

An alternative approach is equal weight investing. This assigns the same weight to each stock regardless of its size. Using the above example, stocks A, B and C would each account for 33.33% of an ETF.

What’s the difference?

There are advantages and disadvantages to investing in equally-weighted ETFs. When larger companies such as those in the mega cap technology sector do relatively well, an equally-weighted fund will underperform. Conversely, when smaller companies do relatively well, they will outperform. 

In other words, traditional market cap weighted ETFs have a size bias. The removal of this bias is one of the attractions of equally-weighted ETFs. Equal weight investors sleep better knowing that no single stock or group of stocks will dictate performance. Stock A could be one negative headline away from crushing a market weighted portfolio, but if equally weighted, the damage would be lessened.

With this in mind, let’s look at three equally-weighted ETFs that have offered superior diversification and risk adjusted returns. 

#1 - EQWL 

The Invesco S&P 100 Equal Weight ETF (NYSEARCA: EQWL) invests at least 90% of its assets in the S&P 100 Equal Weight Index. As the name suggests, the index is an equally-weighted subset of the biggest 100 companies in the S&P 500. As such, the fund inherently has a mega cap bias, but it offsets this by giving the same importance to each stock.

Over the last 10 years, EQWL has produced an 11.0% total return, placing it in the top spot among more than 800 U.S. large cap funds. Even more impressive, it has generated this performance while taking on average risk relative to its peers. This has earned it the coveted five-star rating from Morningstar. 

After long being considered a large cap blend fund, EQWL has drifted into the large cap value style box in recent years. This is reflected in its 14x forward price/earnings (P/E) ratio, 2.1% dividend yield and exposure to financials and healthcare. A low 0.25% expense ratio is the icing on the cake.

#2 - QQEW

The First Trust NASDAQ-100 Equal Weighted Index Fund (NASDAQ: QQEW) also invests in 100 stocks but is based on the Nasdaq-100 index. It is an equally weighted alternative to the popular Invesco QQQ Trust, which has had a strong run in 2023. While Apple, Microsoft and Alphabet are a combined 27% of QQQ, they represent just 4% of QQEW. 

How has QQEW stacked up? With mega cap tech names like Nvidia, Meta Platforms and Tesla up big year-to-date, QQEW (up 18%) is significantly lagging QQQ (up 38%). Over a 10-year period, the annualized performance gap closes to approximately 5% in favor of QQQ.

So why invest in QQEW if it has historically underperformed QQQ? Because QQEW has enjoyed pockets of outperformance, particularly after mega cap names have had a big run. Since the Nasdaq-100’s July 19th peak, smaller companies like PDD Holdings, Amgen and Constellation Energy have been the best performers. This could signal that investors are pulling money out of the big winners — and that an equally-weighted Nasdaq portfolio may be on the brink of outperformance.

#3 - RSPN

Equally-weighted funds are also available at the sector level. The Invesco S&P 500 Equal Weight Industrials ETF (NYSEARCA: RSPN) is a prime example. The fund invests in the 78 industrial sector representatives in the S&P 500 on an equally-weighted basis. 

Keep in mind that individual stock weightings deviate from being identical because of daily market movements. Fund managers periodically rebalance though, typically on a monthly or quarterly basis. This is why, for instance, a recent winner like Northrop Grumman currently has a 1.6% weighting and United Airlines has only a 1.1% weighting.

The main draw for RSPN is that it offers diversified exposure to a range of industries from aerospace and defense to construction and machinery. As the decade progresses, U.S. infrastructure spending and industrial automation are poised to be among the sector's biggest growth drivers. The five-star RSPN ETF has these areas well-covered and then some. Over the last 10 years, the fund has an 11.5% annualized return — which puts it in the top decile of U.S. industrials funds.