Equal weight investing is an investment strategy that gives equal weight to each stock in a portfolio, rather than weighting based on market capitalization. This strategy can outperform in some stock examples over time. Key factors for the outperformance include less exposure to overvalued large-cap stocks, automatic rebalancing, and contrarian betting against market momentum.
Equal weight S&P 500 ETF outperformed market cap weighted S&P 500
One key example is the performance difference between the Invesco S&P 500 Equal Weight ETF (RSP) which tracks the equal weight version of the S&P 500 index, versus the regular market cap weighted S&P 500 ETFs like SPY or VOO. From 2003-2022, RSP returned an annualized 12.3% compared to 9.8% for SPY. The main driver of excess returns was RSP had less exposure to mega-cap tech stocks that became overvalued.
Equal weight Nasdaq 100 strategy beat market cap Nasdaq 100
Another example is the Invesco EQQQ Nasdaq-100 Equal Weighted Index Fund (QQEW) which tracks an equal weight version of the Nasdaq 100 index. From 2010-2022, QQEW returned 13.8% annualized versus 12.9% for the market cap weighted Invesco QQQ Trust ETF (QQQ). Again, avoiding overweight positions in mega-cap tech stocks was a key factor.
Mechanical process enforces discipline selling winners, buying losers
A benefit of equal weighting is it follows a mechanical process of automatically rebalancing on a regular basis. This enforced discipline results in selling appreciated large-cap winners and adding to underperforming smaller stocks. Over long periods, this contrarian approach produces better returns compared to chasing past winning momentum stocks.
Equal weight value and small-cap strategies also fruitful
Beyond just large-cap indexes, equal weighting has also proven effective in value and small-cap stock strategies. As examples, the Invesco S&P 500 Equal Weight ETF (RSPV) and Invesco S&P SmallCap 600 Equal Weight ETF (EWSC) have outperformed their market cap weighted equivalents over the past 10+ years.
In several example cases, equal weight investing strategies have demonstrated the ability to produce long-term outperformance versus market capitalization weighted equivalents. Key drivers include avoiding overvalued mega-cap stocks, enforced discipline selling past winners and buying recent losers, and capitalizing on contrarian opportunities.