Equal weighting arguably provides more, or perhaps better, diversification than cap weighting because it neutralizes concentration risk. The tradeoff, though, could be an increase in volatility. Larger-cap stocks tend to be less volatile than smaller-cap stocks. One response to that volatility, suggests Morningstar analyst Michael Rawson, is to hold sector-specific funds like the Guggenheim S&P 500 Equal Weight Energy ETF (RYE).
One downside to either of these strategies is higher costs. The further you get from passive, the higher expenses go. Fundamentals-based and equally weighted index ETFs have expense ratios that run somewhere between the cap-weighted variety, which can cost less than 0.10 percent, and outright actively managed funds, whose fees can run as high as 2 percent. As for the funds mentioned in this article, it's 0.17 percent for VFINX, 0.39 percent for PRF, 0.40 for RSP, and 0.50 percent for RYE, all according to Morningstar.
And, the eternal question: Do you get better performance for those fees? The picture is mixed. VFINX has trailed the S&P over the past three years in terms of annualized returns (13.45 percent vs. 13.60 percent) and five years (1.43 percent vs. 1.51 percent).
PRF trails the S&P over three years (11.96 percent) but beats it over five (2.11 percent).
RSP beats the S&P over both three- and five-year periods (14.71 percent and 2.66 percent, respectively).
RYE slightly underperforms the S&P energy index over three years (13.46 percent) but outperforms over five (3.5 percent). It well outperforms Morningstar's equity-energy category, which has a return of 4.83 percent for three years and -2.15 percent for five years.
So is it possible, after all, to beat traditional indexing by being more active? A 2009 study by University of Regensburg scholars Christian Walkshausl and Sebastian Lobe, using data generated from 1982 to 2008, finds evidence that fundamentals-weighted portfolios "can outperform their capitalization-weighted counterparts on a global level and in 44 countries," but what explains much of the outperformance is "augmented exposure to value stocks."