Not All Diversification Strategies Are Equal

Advisors searching for diversification from a concentrated S&P 500 Index often reach for equal-weight strategies. However, a new report argues that all equal-weight approaches are not interchangeable.Key Takeaways: Equal-stock and equal-sector weighting solve different problems, and mixing them up can hurt a portfolio’s diversification. Equal-stock strategies can create unintended tilts toward smaller, weaker companies rather than true diversification. EQL equally weights all 11 market sectors while keeping larger companies at the top within each sector. In recent commentary, SS&C ALPS Advisors’ Laton Spahr argues that equal-stock and equal-sector weighting solve entirely different problems, and that confusing the two can leave a portfolio exposed in ways investors may not anticipate. The S&P 500 Index has grown top-heavy, with a small group of mega-cap companies driving much of its returns. Equal-stock and equal-sector strategies are two common alternatives, but the report argues they are too often treated as the same thing. Equal-stock weighting gives every company in the index the same allocation, regardless of quality. According to Spahr, this shifts capital away from the largest, most profitable, and economically dominant firms toward smaller, structurally challenged ones. The portfolio, he wrote, ultimately “owns the ‘thorns’ in the same proportion as the ‘roses.’” Beyond that quality concern, equal-stock strategies tend to drift toward smaller companies, deeper value exposures, and higher-volatility names, creating what Spahr describes as an accidental bet on size and value rather than a genuine diversification strategy. Equal-sector weighting targets the problem differently. Rather than treating every stock equally, it manages risk at the sector level, where much of today’s real market concentration lives. Cap-weighted indexes can look diversified on the surface while a narrow band of economic factors still drives them, according to the report. Spreading exposure evenly across all 11 sectors, including technology, energy, industrials, and consumer staples, distributes a portfolio to a broader range of economic conditions and cash flow cycles, while preserving access to the top companies within each sector, Spahr noted.A Stronger Diversification Record Over a DecadeA Bloomberg growth-of-$100 chart in the commentary, spanning April 2016 through April 2026, shows the NYSE Equal Sector Weight Index outpacing the S&P 500 Equal Weight Index over that stretch. The trend suggests that targeting risk at the sector level produced better long-term results than equal-stock weighting. For investors looking to apply that approach, the ALPS Equal Sector Weight ETF (EQL B) now tracks the VettaFi Modelist Equal Weight Sector 500 Index, which equally weights all 11 market sectors, according to VettaFi. See more: ALPS EQL Swaps SPDR ETFs for New VettaFi Index Within each sector, the index ranks individual stocks by float-adjusted market capitalization, per VettaFi. That means that larger companies by available share count carry more weight. EQL holds $733 million in assets under management and carries a net expense ratio of 0.27%, according to ETF Database. That structure naturally lifts exposure to sectors like energy, materials, utilities, and real estate, underrepresented in cap-weighted indexes, while still preserving access to dominant companies within each sector, according to Spahr. For more news, information, and analysis, visit the ETF Building Blocks Content Hub. VettaFi LLC (“VettaFi”) is the index provider for EQL, for which it receives an index licensing fee. However, EQL is not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of EQL.