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I don't see the fundamental distinction between this and a S&P 500 index fund. Instead of carrying out one rebalancing (at whatever frequency) there's now two r

I don't see the fundamental distinction between this and a S&P 500 index fund. Instead of carrying out one rebalancing (at whatever frequency) there's now two rebalacning steps -- one at the sector level and then another one to account for market cap changes within the sector. The net result of either strategy looks to be an imperfectly realized approximation of the performance a continuously adjusted market cap weighted portfolio of those 500 stocks. Is the claim that this is somehow a better approximation? Are there some tax loss harvesting benefits? What am I missing?

im3w1l 13y ago
The 500 fund has sector weightings based on market cap. This one has equal weightings.
- bradleyjg 13y ago
  Yes, you are exactly right, that's what I was missing. Is there any theory behind this sort of weighting or is just one of those things that someone figured was worth a shot?
  - pyguysf 13y ago
    Yes, the rationale is to maintain equal sector exposures across your portfolio.
    - bradleyjg 13y ago
      That's tautological. Is there any reason rooted in -- for example -- portfolio theory to believe such a strategy will outperform market cap weighting on a risk adjusted basis?
      - fawce 13y ago
        Sector weighting equally is based on diversification. Market cap weighting will tend to bet more on winners (the market cap is going up), concentrating your investment there. Another way to think about it: market cap weighting is a momentum strategy. Equal across sectors is mean reversion.
      - pyguysf 13y ago
        In the broader topic of portfolio management, equal weighting will outperform cap weighting due to the small cap effect (read up on Fama-French three factor model). tldr: historically small caps outperform large caps. In this case, the equal weighting is abstracted away by 1 layer - each ETF is already cap weighted, so you aren't getting the full effect of equal weighting. Instead, you're reallocating to the ETF that has underperformed relative to all others, so as already pointed out, you are betting on reversion rather than momentum.
        im3w1l 13y ago
        >equal weighting will outperform cap weighting due to the small cap effect Just because the sector is big doesn't mean the companies in that sector are big.
        pyguysf 13y ago
        The small cap effect has nothing to do with sectors. If the sector is big because it has a lot of medium/small sized constituents you gain from this implementation because a cap weighted index would under allocate to these smaller names.
aet 13y ago
The costs of this strategy are hidden in the trading. Every time you trade, you incur a cost. Lets say your brokerage commission is $0 - you still pay the spread when you trade and taxes when you sell. Fees for this look reasonable, but why not hold VTSAX which holds approximately 3700 stocks at 0.05% (5bp) expense a year.
- jannotti 13y ago
  They claim that their backtesting mechanism accounts for the spread. Your guess is as good as mine whether they do so perfectly.
Beliavsky 13y ago
The rationale for equal-weighting is that cap-weighting will have you over-invested in stock sectors that are priced too high. If tech stocks have a huge run and double their weight in the S&P, do you want them to represent twice as much of your portfolio? If you think the market is efficient you do, otherwise maybe not.
pyguysf 13y ago
You are correct that it is basically recreates an S&P index fund, but so is the EQL etf, and people have put $125M in it and pay 0.5%/year. I think this is more proof of a) how to recreate something that is already out there for cheaper, and b) the framework for customizing something to your own investment strategy. Maybe you don't need all 11 ETFs under there, maybe you just want Tech+Energy+Fin and you equal weight those - they're giving you the framework you just have to customize it to your needs.
fawce 13y ago
The strategy is not attempting to approximate the S&P 500, it is seeking to manage your exposure to these industries. The algo author wrote a detailed explanation of the outperformance of the S&P 500 here (source code included): https://www.quantopian.com/posts/equal-weight-all-sector-strategy-vs-spy https://www.quantopian.com/posts/equal-weight-all-sector-str...

im3w1l 13y ago

The 500 fund has sector weightings based on market cap. This one has equal weightings.

bradleyjg 13y ago
Yes, you are exactly right, that's what I was missing. Is there any theory behind this sort of weighting or is just one of those things that someone figured was worth a shot?
- pyguysf 13y ago
  Yes, the rationale is to maintain equal sector exposures across your portfolio.
  - bradleyjg 13y ago
    That's tautological. Is there any reason rooted in -- for example -- portfolio theory to believe such a strategy will outperform market cap weighting on a risk adjusted basis?
    - fawce 13y ago
      Sector weighting equally is based on diversification. Market cap weighting will tend to bet more on winners (the market cap is going up), concentrating your investment there. Another way to think about it: market cap weighting is a momentum strategy. Equal across sectors is mean reversion.
    - pyguysf 13y ago
      In the broader topic of portfolio management, equal weighting will outperform cap weighting due to the small cap effect (read up on Fama-French three factor model). tldr: historically small caps outperform large caps. In this case, the equal weighting is abstracted away by 1 layer - each ETF is already cap weighted, so you aren't getting the full effect of equal weighting. Instead, you're reallocating to the ETF that has underperformed relative to all others, so as already pointed out, you are betting on reversion rather than momentum.
      - im3w1l 13y ago
        >equal weighting will outperform cap weighting due to the small cap effect Just because the sector is big doesn't mean the companies in that sector are big.
        pyguysf 13y ago
        The small cap effect has nothing to do with sectors. If the sector is big because it has a lot of medium/small sized constituents you gain from this implementation because a cap weighted index would under allocate to these smaller names.

aet 13y ago

The costs of this strategy are hidden in the trading. Every time you trade, you incur a cost. Lets say your brokerage commission is $0 - you still pay the spread when you trade and taxes when you sell. Fees for this look reasonable, but why not hold VTSAX which holds approximately 3700 stocks at 0.05% (5bp) expense a year.

jannotti 13y ago
They claim that their backtesting mechanism accounts for the spread. Your guess is as good as mine whether they do so perfectly.

Beliavsky 13y ago

The rationale for equal-weighting is that cap-weighting will have you over-invested in stock sectors that are priced too high. If tech stocks have a huge run and double their weight in the S&P, do you want them to represent twice as much of your portfolio? If you think the market is efficient you do, otherwise maybe not.

pyguysf 13y ago

You are correct that it is basically recreates an S&P index fund, but so is the EQL etf, and people have put $125M in it and pay 0.5%/year. I think this is more proof of a) how to recreate something that is already out there for cheaper, and b) the framework for customizing something to your own investment strategy. Maybe you don't need all 11 ETFs under there, maybe you just want Tech+Energy+Fin and you equal weight those - they're giving you the framework you just have to customize it to your needs.

fawce 13y ago

The strategy is not attempting to approximate the S&P 500, it is seeking to manage your exposure to these industries. The algo author wrote a detailed explanation of the outperformance of the S&P 500 here (source code included): https://www.quantopian.com/posts/equal-weight-all-sector-strategy-vs-spy https://www.quantopian.com/posts/equal-weight-all-sector-str...