Equal Weight
Candlefocus EditorThe rationale behind equal-weight indices is that larger stocks tend to outperform smaller stocks over any given period of time. Therefore, by allocating the same weight to each stock in an index, this helps to mitigate risk, since smaller stocks might be able to return more than larger stocks in any given market period. In addition, there is an implicit belief that small-cap stocks tend to have greater growth potential than large-cap stocks. Thus, an equal-weighted portfolio may benefit from greater exposure to these stocks, leading to potentially higher returns, albeit with more risk.
One major advantage of equal-weight indices is that that they have outperformed their market-cap weighted counterparts over some periods. For example, The equal-weighted S&P 500 index has outperformed the regular S&P 500 index by 17.08% since 2003. However, it is important to note that this performance may be attributed to certain market cycles, such as the rising bond yields in 2020 that provided a tailwind to small and mid-cap stocks.
However, equal-weighted funds do have some drawbacks. Due to the higher stock turnover, equal-weighted funds usually carry higher trading costs than market-cap weighted funds. In addition, since the asset allocation of the fund does not change with capitalization and stock prices, it tends to involve a more frequent and expensive rebalancing process. Finally, although equal-weighted portfolios have outperformed the market-cap weighted index funds over some periods, there are no guarantees that this will continue in the future.
Overall, equal-weighted portfolios can offer investors a more diversified approach to investing, but they come with the associated risks and trading costs. Ultimately it is up to each individual investor to decide if the additional diversification and potential outperformance is worth the associated risks.