Equal-Weighted Stock Indexes Can Have Powerful Benefits

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Historical Results

We looked into the performance of 8 developed markets for the period from 1985-2013. The results are below. They show that, except for Australia and Italy, an equal-weight index would have outperformed each market cap index.

The volatility column also shows that there is not much more risk with this strategy, even though a higher weighting is given to smaller companies using the equal-weighted method. So, with an equal-weighted index, you get better performance without taking on a lot more risk.

Performance of cap weight and equal weight strategies by country (1985-2013)

	Performance		Volatility
	CAP	EW	CAP	EW
Australia	12.4%	11.7%	23.4%	23.7%
Canada	10.1%	11.2%	18.7%	18.4%
France	12.8%	14.1%	21.3%	21.7%
Germany	11.4%	12.4%	22.0%	19.8%
Italy	10.0%	9.9%	25.6%	25.5%
Japan	5.0%	6.2%	22.1%	21.7%
United Kingdom	11.7%	12.6%	18.0%	19.2%
United States	9.9%	11.0%	15.0%	16.4%

Source: Research Affiliate LLC

There are a couple of reasons why an equal weight index outperforms market cap indices. For one thing, there is a higher weighting to small-cap and value stocks. These have historically outperformed growth and large-cap stocks over time.

Another reason has to do with the rebalancing. Imagine one stock in the index has a good year and jumps from a 5% to 7% weighting, while another stock doesn’t do as well and its weighting falls from 5% to 3%. When the portfolio is rebalanced back to an equal weighting, you will be selling one stock at a high price and buying more of the other at a low price. In other words, it forces you to buy low and sell high, the most basic rule in investing. A market cap weighted index does not always do this.

 

http://www.forbes.com/sites/peterpham/2016/03/29/the-benefits-of-an-equal-weighted-stock-index/#777a221d3325