The equal weight investing strategy is an alternative approach to constructing investment portfolios compared to the more common market capitalization weighting. This strategy assigns equal weights to each constituent in the portfolio instead of weighting them based on their market size. It can provide diversification benefits and reduces concentration risk. In this article, we will explore an example of the equal weighting methodology and its key features.
What is equal weight investing?
Equal weight investing aims to assign equal risk contribution to each security in a portfolio, regardless of the market capitalization or stock price. Rather than overweighting larger companies by market cap as in traditional indexing, it gives equal importance to all components, including smaller companies.
An example index construction
An equal weight index that tracks the S&P 500 would invest roughly 0.2% of the portfolio into each of the 500 constituent stocks instead of companies like Apple and Microsoft making up 4-5% based on size. At periodic rebalances, position sizes would be reset back to equal weight.
Key advantages
Equal weighting reduces concentration risk and tilts exposure towards historically better performing smaller caps. It exploits the tendency of smaller stocks to eventually become tomorrow’s mega caps while avoiding overweight positions during bubble phases. The strategy diversifies risk contribution across constituents.
Potential drawbacks
More frequent rebalancing leads to higher turnover and trading costs. Also, equal weighting may underperform during strong, momentum-driven bull markets when mega cap tech stocks extend their leadership. The methodology is still largely focused on large caps due to index membership requirements.
In summary, equal weight indexing provides an alternative to traditional market cap weighted portfolios by assigning equivalent importance to smaller and larger stocks. While no strategy can outperform in all market environments, equal weighting has demonstrated long-term efficacy with diversification benefits.