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Investment thesis
EUSA iShares MSCI USA Equal-Weighted ETF (NYSERCA: EUSA) owns a portfolio of approximately 600 U.S. stocks. The fund's equal-weighting approach is a double-edged sword. While the approach has resulted in lower concentration risk, EUSA's growth outlook is also Limited relative to the S&P 500 index, as this approach has resulted in less exposure to the fast-growing technology sector. Given EUSA's earnings growth outlook lower than that of the S&P 500 index, we cannot give EUSA a buy rating. Investors may want to look at other alternatives instead.
Fund analysis
EUSA has a lower concentration risk thanks to its equal weighting strategy
EUSA has a portfolio of approximately 600 US stocks. There is a significant overlap between EUSA and the S&P 500 index, as many of these stocks can be found in the S&P 500 index as well. The difference is that the S&P 500 index is not a US stock. The 500 index is market-cap weighted, while the EUSA is equal-weighted. This means that after each rebalance, all stocks in the EUSA portfolio will have the same weighting. The fund is rebalanced four times a year. However, frequent rebalancing typically involves higher trading costs. Surprisingly, it has a low expense ratio of just 0.09%. Other similar ETFs, such as the Invesco S&P 500 Equal Weight ETF (RSP) has a higher expense ratio of 0.20%. EUSA’s equal-weighted approach means that the fund is diversified, as no stock in its portfolio will account for more than 0.167% of the total portfolio after each rebalancing. In terms of sector allocation, EUSA is also much more balanced relative to the S&P 500 index. As can be seen in the chart below, no single sector accounts for more than 16% of EUSA’s total portfolio.
iShares
Overweight in the industrial sector, but underweight in the technology sector
However, a balanced and diversified portfolio in terms of sector allocation may not contribute to better returns. If we compare EUSA’s sector allocation with the S&P 500 index, we see that EUSA is overweight in the industrial sector but underweight in the information technology sector. As can be seen in the table below, the industrial sector accounts for almost 16.0% of EUSA’s total portfolio but only about 8.4% of the S&P 500 index. That is almost double the representation in the S&P 500 index. On the other hand, EUSA’s exposure to information technology is less than half of that of the S&P 500 index. As can be seen in the table, the information technology sector accounts for about 15.3% of EUSA’s total portfolio but almost 31% of the S&P 500 index.
|
USA |
S&P 500 Index |
|
|
Industrial actions |
15.98% |
8.43% |
|
Information technologies |
15.25% |
30.95% |
|
Finance |
15.15% |
13.29% |
|
Health care |
12.46% |
12.19% |
Table: Breakdown of exposure between EUSA and S&P 500
EUSA's lower exposure to the information technology sector and higher exposure to the industrial sector relative to the S&P 500 index are not beneficial. Why do we come to this conclusion? This is because the technology sector is underpinned by several major megatrends such as artificial intelligence, cloud computing, the Internet of Things (“IoT”), industrial automation, etc. These trends should result in strong earnings growth for many technology stocks at least in the next few years. As can be seen in the chart below, annual earnings growth estimates for the information technology sector in 2025 are expected to be 27.6%. This is much higher than the S&P 500’s consensus earnings estimate of 16.4%. On the other hand, the consensus earnings growth rate for the industrials sector is only 14.4% in 2025. This is lower than the earnings growth rates of the information technology sector and the S&P 500 index. Therefore, EUSA’s overweight in the industrials sector and underweight in the information technology sector means that it will likely have lower earnings growth potential than the S&P 500 index, at least in the near term.
Macromicro
EUSA has underperformed the S&P 500 index in the past
Let us now look at how EUSA has performed relative to the S&P 500 index in the past. As you can see in the chart below, EUSA has achieved a total return of 157.9% over the past 10 years. This return is good, but it is still far from being as good relative to the S&P 500 index. As you can see in the chart, the S&P 500 index has achieved a total return of 237.6% over the past 10 years, which is much higher than EUSA.
Charts And
Let us now compare the average annual return over the past 10 years between EUSA and the S&P 500 index. As can be seen in the table below, the average annual return of the S&P 500 index over the past 10 years was 13.1%. This was almost 3.6 percentage points higher than the average annual return of 9.5% for EUSA.
|
As of July 31, 2024 |
USA |
S&P 500 Index |
|
1 year |
13.86% |
22.12% |
|
3 years |
3.09% |
9.57% |
|
5 years |
10.01% |
14.96% |
|
10 years |
9.54% |
13.11% |
Table: Average annual profitability
EUSA’s underperformance is not surprising. As we discussed earlier in this article, EUSA’s equal-weighted approach means that it cannot take full advantage of the strong returns of many growth stocks. For example, Microsoft’s (MSFT) share price has increased by more than 800% over the past 10 years. The S&P 500 market-cap-weighted approach will be able to take full advantage of this stock’s strong performance. In contrast, Microsoft’s contribution to EUSA’s performance is limited due to the fund’s frequent rebalancing.
Conclusion for the investor
EUSA's equal-weighted approach means it has a lower earnings growth outlook than the S&P 500 index. Therefore, we do not believe investors with a long-term earnings horizon need to own this fund.
Additional Disclosure:This does not constitute financial advice and all financial investments involve risk. Investors are expected to seek financial advice from professionals before making any investment.