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Indebta > News > RSPT: A Strategy That Could Pay In The Long Run (NYSEARCA:RSPT)
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RSPT: A Strategy That Could Pay In The Long Run (NYSEARCA:RSPT)

News Room
Last updated: 2023/10/11 at 5:04 AM
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Invesco S&P 500® Equal Weight Technology ETF (NYSEARCA:RSPT) invests in technology stocks within the S&P 500 index (SPY) while allocating an equal weight to each stock. The fund is likely to struggle in the short-to-medium term but I can see it outperforming in the long term because of its strategy which I will explain below.

There are typically 65-70 technology stocks in the S&P 500 index at any given time which make up about 13% of the index in terms of the number of companies but tech stocks account for as much as 30% of the S&P 500’s total weight not to mention how 8 of the top 10 stocks in the index are technology stocks. This fund takes all those technology stocks and gives them all an equal weight of 1.50% regardless of how big or small they are. This approach seems to be working since the fund was able to outperform the overall market by a nice margin in the last 10 years as you can see below.

Chart
Data by YCharts

One of the major criticisms people have lately about the stock market is that the market’s performance is driven by 8-10 mega-cap stocks while everything else is struggling so any index that’s overweight those stocks will likely outperform but this is recency bias which says that people have the tendency to look at a recent trend and falsely believe that the trend will always be there. We’ve had periods where mega caps outperformed and carried indices but we also have periods where mega cap tech stocks underperformed and dragged indices such as last year.

Since stocks move every single day and some become more expensive while others become cheaper, the fund has to rebalance its holdings every single day to ensure that it stays truly equally weighted. If it didn’t, some stocks would quickly claim higher weighting while others would lose their weighting within the fund. For example, if you have a fund that holds 100 stocks and each stock is equally 1% of the fund and one of the stocks suddenly doubles while another stock drops by 50%, the first stock will now have 2% of the fund’s total weight while the second one will have 0.5% of its weight and over time the fund’s weight would be very similar to the weighting of the overall index which would defeat its whole purpose.

The fund rebalances its portfolio on a daily basis which has three implications for investors, some positive some negative. First, it makes it very difficult if not impossible for a regular investor to replicate this fund’s strategy. It would be extremely costly and cumbersome for a regular investor to rebalance their portfolio. The fund does this automatically using software that minimizes costs and errors associated with moving things around very frequently.

Second, in order to rebalance its portfolio, the fund has to sell stocks that are rising and buy stocks that are falling. Obviously, this has implications that can be both positive and negative. On the positive side, the fund is buying more stocks that are getting cheaper and less stocks that are getting more expensive. For example, if NVIDIA (NVDA) suddenly gains 10%, the fund will trim its NVDA position by 10% which means it will reduce its exposure to a stock that’s getting more expensive. Similarly, if AMD (AMD) were to drop by 10%, the fund would increase its AMD holdings by that much and it would be acquiring AMD shares on the cheaper.

But there is also a negative side to this. The fund is basically trimming stocks that are winning and adding to stocks that are losing. Basically, the fund is betting against an existing trend where it buys more of falling stocks and less of rising stocks. In the long run, this should all balance out when valuations win over short-term trends but it could make things a bit bumpy in the short term.

The fund hasn’t updated its valuation metrics since last spring but its average P/E ratio stood at 21 and its forward P/E stood at 20 whereas Nasdaq’s tech index had a much higher P/E ratio of 27 at the time.

Fund characteristics

Fund characteristics (Invesco)

When we look at P/E ratios of some of the mega-cap stocks that dominate indices today, we see P/Es ranging from 29 to 110. Three out of these 7 companies had a P/E ratio above 70 and not a single one had a P/E ratio below 25. These 7 companies claim about 20% of S&P 500’s total weight and 25% of Nasdaq’s weight. Combined together, they make up only 10% of this fund’s weight in comparison.

Chart
Data by YCharts

These stocks are up more than 30% year to date but almost all of that performance came from P/E expansion while earnings were relatively flat. Apart from Amazon (AMZN) and Nvidia every single one of them reported flat-to-down earnings from last year even though their stocks are through the roof lately. If you believe that these stocks will continue rallying on multiple expansion alone and their multiples will keep rising forever, that’s one thing but if you don’t, this fund with equal weights makes sense to at least take a look at.

Chart
Data by YCharts

The fund has a relatively high expense ratio of 0.40% for an index fund but most of the costs are associated with daily rebalancing of its portfolio which can be very costly. One thing to keep in mind is that daily rebalancing of its positions could have tax implications for the fund since it would have to constantly take profits or losses on its positions on an almost daily basis.

If you are a long-term investor with a multi-decade focus and are in the accumulating stage, this fund could be a good addition to your portfolio. In the short term, it may not outperform due to its counter-trend focus but in the long term, it is likely to outperform if valuations eventually win.

Read the full article here

News Room October 11, 2023 October 11, 2023
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