Investors in search of a core U.S. equity holding naturally seem to gravitate toward traditional index products such as SPDR S&P 500 ETF (NYSE:SPY), where the holdings are structured by market capitalization (meaning that the largest companies have the largest weightings). However, the return data reveals that investors should take a closer look at the Guggenheim S&P 500 Equal Weight ETF (NYSE:RSP) — which holds the same weighting in each of the index’s 500 stocks — for their core U.S. investment.

The divergence in performance between the two ETFs shows a substantial impact from the different weighting methodology, and it helps make the case for replacing SPY or similar funds with an equal-weighted portfolio.

Since its inception May 2, 2003, RSP has delivered an average annual total return of 10.13%, well above the 7.25% return of SPY. Much of this advantage can be attributed to RSP’s huge outperformance in 2009, when it returned 44.6% beat SPY by 18.3 percentage points. Still, RSP has outperformed in five of nine calendar years and is ahead in the one-, three- and five-year periods:

Given this return gap, it might come as a surprise that the Guggenheim ETF — despite attracting $966 million in new cash during the past six months — still has just $4 billion in assets, which leaves it deep in the shadow of the $125 billion invested in SPY.

While investors haven’t picked up on RSP’s performance just yet, it makes sense that an equal-weighted approach to investing in the S&P 500 would deliver outperformance in over time. A cap-weighted index is heavily tilted toward mature, mega-cap companies with less upside, whereas the equal-weighted index has a larger position in the smaller end of the large-cap range — an area that should put up better performance numbers over the long-term.

An equal-weighted index also suffers less of an impact when a single holding blows up, as Apple (NASDAQ:AAPL) has in the past six months, which means investors can own stocks without exposure to outlier results from individual companies.

Finally, the quarterly rebalancing of the equal-weighted strategy prompts it to sell winners and add shares of laggards, creating a steady bias in favor of buying low and selling high.

Curious investors might wonder what specific drivers have enabled RSP to outperform by such a wide margin. Fortunately, Guggenheim also has nine equal-weighted sector ETFs that have been open since November 2006. Since that time, the equal-weighted approach has led to outperformance in seven of nine sectors, with financials, health care and materials the source of the largest performance advantage, and technology, consumer discretionary, and energy pulling up the rear. The full data set is available here.

Questionable Results Elsewhere

Aside from RSP, equal-weighted ETFs has been generally unsuccessful. The First Trust NASDAQ-100 Equal Weighted Index Fund (NASDAQ:QQEW) has comfortably outpaced PowerShares QQQ Trust (NASDAQ:QQQ) in the one-year period — 10.77% to 7.54% — due largely to the collapse of Apple, which at its peak made up almost 20% of QQQ. Still, QQQ is ahead on both a three- and five-year basis:

An equal-weighted approach also provided little advantage in the small-cap, mid-cap or developed-market international spaces, where all of Guggenheim’s funds underperformed their cap-weighted counterparts and are slated to close on Friday.

Similarly, the Guggenheim MSCI Emerging Markets Equal Weight ETF (NYSE:EWEM) has returned -3.63% and lagged the -0.31% return of iShares MSCI Emerging Markets Index Fund (NYSE:EEM) in the same interval.

Relative performance might not matter much here either, as the fund holds $14 million in assets — only about $2 million more than EWEF — and could therefore be in jeopardy of closing before long.

The Bottom Line

While an equal-weighted approach hasn’t worked outside of the large-cap space, the performance results of RSP — together with the qualitative reasons for owning an equal-weighted fund in the large-cap space — indicate that investors who own traditional funds as a core large-cap holding should consider the Guggenheim S&P 500 Equal Weight ETF.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.