Get Creative With Alternative Weighting ETFs

Alternative #1:
Equal Weighting

This approach is strikingly simple: Just divide the money between all the stocks in an index equally. If your index consists of 50 stocks, each one gets 2 percent.

Equal weighting treats all stocks the same.

Equal weighting was pioneered by Rydex, which offers a series of ETFs using this methodology. Rydex S&P Equal Weight ETF (RSP) owns the same stocks as the S&P 500 but with equal-weighting rather than cap-weighting.

Comparing SPY vs. RSP reveals how big the difference in returns can be ...

In the first eight months of 2009, SPY (including dividends) was up 15 percent. RSP gained 29 percent during the same period.

How does this happen?

The smaller-cap stocks get a bigger weighting in RSP than they do in SPY. And those stocks have done generally better this year than most of the mega-cap issues. This isn't always the case. But equal weighting clearly had a huge positive impact so far this year.

In addition to RSP, here are some other equal-weighted ETFs you might want to consider:

• SPDR S&P Biotech ETF (XBI)
  
  
• First Trust Nasdaq-100 Equal Weighted Fund (QQEW)
  
  
• SPDR S&P Semiconductor ETF (XSD)

Alternative #2 and #3:
Dividend and Earnings Weighting

If you love income, then you'll probably want to tilt your portfolio toward the stocks with a record of growing their dividends. So take a look at the ETFs offered by WisdomTree.

WisdomTree argues that, by design, cap-weighted ETFs are forced to buy high and sell low. Here's why that's true:

The higher a stock's market capitalization (shares outstanding multiplied by the share price), the more shares a cap-weighted ETF buys. If those share prices decline, the market capitalization of the stock declines as well. Consequently, they are replaced with higher-cap stocks when the ETF rebalances its portfolio.

WisdomTree's solution is a set of indexes that use fundamental factors like dividends and earnings to allocate among stocks. They think this will lead to better long-term results, and they have a lot of research to support their point.

Fundamental factors are more objective than stock prices.

One advantage of this approach is that dividends and earnings are much more objective than stock prices as a way of measuring a company's success. We've all seen stocks launched into orbit by irrational investors chasing surging stock prices, only to come crashing back down.

Dividends aren't so easily manipulated. And screening for companies with consistent earnings can help weed out the money-losing and speculative ones.

WisdomTree has a whole family of ETFs that follow variations on this theme. Some of the most popular are:

• WisdomTree Dividend excluding Financials (DTN)
  
  
• WisdomTree India Earnings Fund (EPI)
  
  
• WisdomTree Emerging Markets SmallCap Dividend (DGS)

Alternative #4:
Revenue Weighting

Another methodology is offered by a company called RevenueShares. The name gives away their strategy: Stocks in their ETFs are weighted by revenue.

Revenue is even more resistant to manipulation than earnings. In accounting lingo, it's the "top line" of money coming in. Public companies are required to disclose it in their SEC filings, so the information is readily available.

Revenue is what makes companies grow.

RevenueShares says that weighting stocks by their revenue can deliver attractive returns over time. Though of course it doesn't mean their strategy will work all the time. Here are some of the best-known RevenueShares ETFs:

• RevenueShares Small Cap (RWJ)
  
  
• RevenueShares Mid Cap (RWK)
  
  
• RevenueShares Large Cap (RWL)

Alternative #5:
Combinations of Fundamental Weightings

Alternatives #2 — #4 discussed above are sometimes referred to as fundamental weighting. Rob Arnott, of Research Affiliates, has created fundamentally weighted indexes using a combination of factors such as sales, book value, dividends, and cash flow. And he has teamed up with FTSE to offer the FTSE-RAFI indexes.

Some of the ETFs using this approach include:

• PowerShares FTSE-RAFI US 1000 (PRF)
  
  
• PowerShares FTSE-RAFI Emerging Markets (PXH)
  
  
• PowerShares FTSE-RAFI US 1500 Small-Mid (PRFZ)

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