Market-Cap Weighted or Equal-Weighted ETFs?

First Published: ADawnJournal.com May 30, 2010

Buying exchange-traded funds in Canada got much easier thanks to BMO Financial Group and the release of eight different ETFs that are equal-weighted and three that are currency-hedged. These two different types of ETFs are part of a key strategy by the Bank of Montreal to help set itself apart from ETFs that are put out by iShares and Vanguard, which currently dominate the market.

The currency strategy uses hedging to hedge foreign funds back into the Canadian dollar and this has actually been used quite a bit by iShares and Criterion Investments, which focuses only on currency hedging. However, that is not what is putting the Bank of Montreal in the papers these days; equal-weighting is.

Critics of ETFs say that market-cap weighted funds created high concentrations of large-cap stocks that are often over-valued. When the large-cap stocks get more and more overvalued, there is a greater weighting on them in the fund and that creates a higher risk for investors who put their money into the ETF. However, according to BMO, equal-weighting prevents this and therefore makes investing safer for ETF investors. How it works is if the top 10 stocks on the TSX represent 40 percent of the market cap of the index, equal-weighting puts every stock at the same weight no matter how large or small the market cap. That means that if there are 50 stocks on an ETF, each stock has a two percent weight within the stock.

However, BMO is not the only ones who offer the equal-weighted ETFs. Claymore Investments also offer them and the company states that it helps investors avoid overweighting overvalued stocks and underweighting undervalued stocks. Critics of the ETF state that often happens, as we have said, with ETFs that are not equal-weighted.

Exchange-traded funds are often looked at as a safe investment for many investors because with these you are not trying to beat the market, but instead just mirror the index. Too many times investors want to beat the stock market and that leads many of them down a road to ruin. With exchange-traded funds, even those that are not equal-weighted, there is a much safer path to go down. No, you do not make as much with these funds but if you can diversify your portfolio with them you help the hedge your bets in case the market takes a downturn.

It is very important that you do not put all your eggs in one basket. Now, with the equal-weighted ETF from banks and companies like Bank of Montreal and Claymore Investments, it is possible to make the safe investment of an ETF even safer for investors. You can expect that in the coming years, many investors will be putting their money into the equal-weighted ETFs instead of risking it in mad-cap investments that could cost the investor everything they have

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