One S&P index doing fine

NEW YORK – Poor performance among mega-cap stocks has dragged the Standard & Poor’s 500 down lately, along with the index funds that track it. But one version of the S&P 500 hasn’t come under quite as much pressure, and big investors are starting to take notice.

The benchmark S&P 500 index, a market-weighted basket of 500 widely held stocks, is often hailed as the best snapshot of the overall market. But because its constituents are weighted by market cap, the 175 largest issues control about 80 percent of the index’s movement. That can mean tough times when mega-caps are down, a point that’s been underscored recently by an investigation of the insurance industry and problems facing large drug companies.

This mega-cap bias is eliminated in the S&P Equal Weighted Index, which follows the same list of stocks in another way – often with dramatically different performance, depending on market conditions. Unlike the market-weighted version, the equal-weighted S&P index allocates a fixed 0.20 percent weighting to each of the 500 securities.

Advocates say the equal-weighted structure offers greater diversity and limits over-concentration by sector or market-cap. Detractors are unconvinced, arguing that the whole point of indexing is to own the market, and if you discard market-weightings, you lose that benefit.

Research conducted by S&P found the equal-weighted index does offer some distinct advantages, however. In addition to higher exposure to the smaller large-caps, it delivers greater value exposure, which some investors may find appealing. But what’s really piqued the interest of institutional investors is the equal-weighted index’s performance history. It has beaten the traditional benchmark consistently, returning 12.65 percent over the last 10 years, compared to 11.09 percent for the S&P. Over the last five years, it has gained 7.08 percent, compared to a 1.31 percent decline for the traditional index. And for the 12 months ending Sept. 30, the equal-weight index was up 19.76 percent, compared to just 13.87 percent for the S&P.

“When people look at the numbers and compare, that’s the first thing that strikes them, and that’s what’s created the interest we’ve seen,” said Srikant Dash, index strategist with Standard & Poor’s. “We’ve seen a lot of money flowing in from institutions over the last three months.”

While assets linked to the equal-weighted index are nowhere near the $1.1 trillion pegged to the traditional S&P 500 index, interest is on the rise. There’s currently $3.5 billion invested in funds tracking the equal-weighted index, up from $2.4 billion at the end of 2003. A good portion of that has come from state pension funds. According to public filings, the New York State Teachers’ Retirement System invested $1 billion during the summer, and Vermont’s three statewide public retirement plans recently allocated $450 million.

Downsides to the equal-weighted index? Its fixed allocation structure requires more frequent rebalancing – quarterly rather than annually – which leads to higher turnover and increased trading costs.