What Is Equal Weight?
Let me explain equal weight to you directly: it's a type of proportional measuring method that gives the same importance to each stock in a portfolio, index, or index fund. This means stocks from the smallest companies get equal statistical significance, or weight, as those from the largest ones when evaluating the overall group's performance.
You might also hear it called an unweighted index. The key point here is that it levels the playing field, unlike other methods that favor bigger players.
Key Takeaways on Equal Weight
As I see it, equal weight is a straightforward proportional measure that assigns identical importance to every stock in a portfolio or index fund, no matter the company's size. This stands in contrast to weighting by market capitalization, which is far more common in indexes and funds.
I've noticed the concept of equally-weighted portfolios has picked up interest because of the strong historical performance of small-cap stocks and the rise of several exchange-traded funds (ETFs). That said, equal-weighted index funds usually come with higher stock turnover than their market-cap weighted counterparts, leading to elevated trading costs.
Understanding Equal Weight
Equal weight differs from the approach most indexes, funds, and portfolios use, where stocks are weighted by their market capitalization. Many major market indices you know are either market-cap-weighted or price-weighted.
For instance, market-cap-weighted ones like the S&P 500 give more weight to the largest companies by market cap—think Apple and Microsoft as top holdings. Price-weighted indices, such as the Dow Jones Industrial Average (DJIA), prioritize stocks with higher prices.
The appeal of equally-weighted portfolios stems from small-cap stocks' track record and the growth of ETFs. Standard & Poor's has even created over 80 equal-weight indices combining market cap, market, and sector factors.
Performance of Equal-Weighted Indices
Small-cap stocks are typically seen as higher-risk, higher-return options compared to large-caps. In theory, an equal-weight portfolio that boosts the influence of smaller S&P 500 names should enhance overall return potential. Historically, this holds true in the short term—from September 2020 to September 2021, the S&P 500 Equal Weight Index returned 41.93%, outperforming the traditional S&P 500's 33.72%.
Over the long haul, though, the difference shrinks, and actually reverses. The 10-year annualized return from September 2011 to September 2021 for the Equal Weight Index was 15.32%, while the S&P 500 beat it at 16.32%.
Remember, S&P Global launched the S&P 500 Equal Weight Index in January 2003 as an equal-weight take on the S&P 500. Both share the same stocks, but the weighting differences create distinct properties and investor benefits.
Examples of Equal-Weight Funds
Invesco provides over a dozen equal-weight funds covering major indices like the S&P 500 and various sectors. Take the Invesco S&P 500 Equal Weight ETF (RSP)—it gives equal exposure to the smallest S&P 500 companies as to giants like General Electric.
Be aware that equal-weight index funds often have higher portfolio turnover than market-cap weighted ones. This means the manager must regularly rebalance to keep each holding at the same percentage, resulting in higher trading costs and potentially more volatile prices. On the plus side, they offer better protection during large sector downturns.
Other examples include the Invesco Russell 1000 Equal Weight ETF, based on the Russell 1000 Equal Weight Index, and the First Trust NASDAQ-100 Equal Weighted Index Fund, which benchmarks against the NASDAQ-100 Equal Weighted Index.
Fast Facts on Related Indices
- In the SPDR Dow Jones Industrial Average ETF Trust (DIA), which tracks the DJIA, top holdings as of September 2021 include UnitedHealth Group, Goldman Sachs, and The Home Depot.
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