However, equal-weight ETFs have some trade-offs. One is cost. EQL has a 0.2% management expense ratio (MER), and QQEQ is 0.28%, compared to just 0.09% for market-cap weighted S&P 500 ETFs and 0.2% for Nasdaq-100 ETFs.
Another downside is historical underperformance. Over the last five years, EQL returned 13.42% annualized, while the iShares Core S&P 500 Index ETF (XUS) delivered 14.84%. The gap is even more pronounced for Nasdaq-100 exposure. QQEQ’s three-year annualized return was 12.12%, compared to 18.59% for the market-cap weighted Invesco NASDAQ 100 Index ETF (QQC).
A big reason for this is that equal-weight ETFs don’t let the winners run. In a market-cap weighted ETF, outperforming stocks naturally rise to the top, increasing their influence over time.
In an equal-weight ETF, these winners are systematically trimmed every quarter, while underperformers get bought back up to target weight. This reduces concentration risk, but also means the fund misses out on extended bull runs in dominant sectors like tech.
Capped index ETFs
Some indexes impose caps on single-company weights to prevent concentration risk. A well-known example in Canada is the S&P/TSX Capped Composite Index, which limits any single stock to 10%. This rule was implemented after Nortel ballooned to over a third of the S&P/TSX 60 in July 2000, exposing investors to extreme sector risk before the stock collapsed in 2009.
For Canadian investors seeking U.S. equity exposure without excessive tech concentration, there’s a similar option now: the iShares S&P 500 3% Capped Index ETF (XUSC). This fund tracks the S&P 500 3% Capped Index, which prevents any one company from exceeding a 3% weighting. If a stock surpasses this limit, the excess weight is trimmed and redistributed across the rest of the index during quarterly rebalances.
A quick look at XUSC’s sector breakdown as of February 12 shows a balanced allocation—just 22.8% in technology. Additionally, the top 10 holdings make up only 24.4% of the ETF.
However, this ETF investing strategy has its drawbacks. XUSC comes with a higher 0.12% management fee, which, while still low, is more expensive than the 0.09% MER of XUS, its market-cap weighted counterpart.
