EUSA’s Underweight in Tech Makes It Less Attractive (NYSEARCA:EUSA)

Investment Thesis

EUSA iShares MSCI USA Equal Weighted ETF (NYSEARCA:EUSA) holds a portfolio of about 600 US stocks. The equal weighted fund approach is a double-edged sword. While the approach has resulted in lower concentration risk, EUSA’s growth outlook is as well limited compared to the S&P 500 index, as this approach resulted in less exposure to the fast-growing technology sector. Given EUSA’s lower earnings growth outlook than the S&P 500, we cannot give EUSA a buy rating. Investors may want to look to other alternatives instead.

Background analysis

EUSA has lower concentration risk due to its equal weighting strategy

EUSA holds a portfolio of approximately 600 US stocks. There is significant overlap between EUSA and the S&P 500 Index, as many of these stocks can also be found in the S&P 500 Index. The difference is that the S&P The 500 index is weighted by market capitalization, while the EUSA is equally weighted. This means that after each rebalancing, all stocks in the EUSA portfolio will have the same weight. The fund is rebalanced four times a year. However, frequent rebalancing usually means 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 an expense ratio greater than 0.20%. EUSA’s equal-weight approach means the fund is diversified, as none of the stocks in its portfolio will represent 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. As can be seen from the chart below, no sector accounts for more than 16% of EUSA’s total portfolio.

Overweight in industrials but underweight in technology

However, a portfolio that is balanced and diversified in terms of sector allocation may not contribute to better returns. If we compare EUSA’s sector allocation to the S&P 500, we see that EUSA is overweight the Industrials sector but underweight the Information Technology sector. As can be seen from the table below, the industrials sector makes up almost 16.0% of EUSA’s total portfolio, but only makes up about 8.4% of the S&P 500. This is almost twice the representation in the index S&P 500. On the other hand, EUSA’s information technology exposure is less than half that of the S&P 500. As can be seen from the table, the information technology sector represents about 15.3% of EUSA’s total portfolio, but almost 31% of the S&P 500 index.

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Table: Breakdown of exposure between EUSA and S&P 500

EUSA’s lower exposure to the information technology sector and higher exposure to the industrials sector compared to the S&P 500 index are not beneficial. Why do we make this conclusion? This is because the technology sector relies on several important mega-trends, including artificial intelligence, cloud computing, the Internet of Things (“IoT”), industrial automation, etc. These trends should result in strong earnings growth for many tech stocks for at least the next few years. As can be seen from the chart below, the consensus annual earnings growth estimates for the information technology sector in 2025 are expected to be 27.6%. This is much higher than the 16.4% consensus earnings estimate for the S&P 500. On the other hand, the consensus earnings growth rate for the industrials sector is only 14.4% in 2025. This is lower than the rates of earnings growth in the information technology sector and the S&P. 500 index. Therefore, EUSA’s overweight to industrials and underweight to the information technology sector means it will likely have lower earnings growth potential than the S&P 500, at least in the short term.

EUSA has outperformed the S&P 500 in the past

Let’s now look at how the EUSA has performed against the S&P 500 in the past. As can be seen from the chart below, EUSA has delivered a total return of 157.9% over the past 10 years. This return is good, but still not that good relative to the S&P 500. As can be seen from the chart, the S&P 500 has delivered a total return of 237.6% over the past 10 years, much more than the EUSA.

Let’s now compare the average annual return over the last 10 years between EUSA and the S&P 500. As can be seen from the table below, the average annual return of the S&P 500 over the last 10 years was 13.1%. This was almost 3.6 percentage points higher than EUSA’s average annual return of 9.5%.

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Table: Average annual yield

EUSA’s poor performance is not surprising. As we discussed earlier in the article, EUSA’s equal weighted approach means it cannot fully benefit from the strong returns of many growth stocks. For example, Microsoft (MSFT) has seen its stock price increase by more than 800% over the past 10 years. The market cap-weighted approach to the S&P 500 will be able to fully benefit from this stock’s strong performance. In contrast, Microsoft’s contribution to EUSA’s return is limited due to the fund’s frequent rebalancing.

Investor Takeaway

EUSA’s equal-weight approach means it has a lower earnings growth outlook than the S&P 500. Therefore, we don’t think investors with a long-term earnings horizon need to own this fund.

Additional Disclosure: This is not financial advice and that all financial investments involve risks. Investors are expected to seek professional financial advice before making any investment.