Equal weight is a type of proportional measuring method that gives the same importance to each stock in a portfolio or index fund. This means stocks of the smallest companies are given equal statistical significance, or weight, to the largest companies when evaluating the overall performance of the group.
An equal-weight index is also known as an unweighted index.
Key Takeaways
- Equal weight is a proportional measure that prioritizes stocks equally in a portfolio or index fund, regardless of a company’s size.
- Equal weight contrasts with weighting by market capitalization, which is more commonly employed by indexes and funds.
- The concept of equally-weighted portfolios has gained interest due to the historical performance of small-cap stocks and the introduction of several exchange-traded funds (ETFs).
- Equal-weighted index funds tend to have higher stock turnover and so typically incur higher trading costs.
Understanding Equal Weight
Equal weight differs from the more traditional method used by indexes, funds, and portfolios where stocks are weighted based on their market capitalization.
Many major market indices are either market capitalization-weighted or price-weighted. For instance, in market-cap-weighted indices like the Standard & Poor’s (S&P) 500, more weight is given to larger companies by market capitalization. Conversely, price-weighted indices like the Dow Jones Industrial Average (DJIA) give larger weightings to stocks with higher prices.
The equal weight approach has gained traction owing to the compelling historical performance of small-cap stocks and the rise of various ETFs. Standard & Poor’s has developed over 80 different equal-weight indices that combine market cap, market, and sector variations.
Performance of Equal-Weighted Indices
Small-cap stocks, generally viewed as higher risk but higher potential return investments compared to large-caps, benefit significantly in equal-weight portfolios. Thus, in theory, giving greater weight to these smaller entities should drive higher return potentials for the portfolio. This has been corroborated short-term, where from September 2020 to September 2021, the total one-year return for the S&P 500 Equal Weight Index (EWI) was 41.93%, outstripping the traditional S&P 500 Index, which returned 33.72%.
Over a longer time frame, however, the returns tend to converge, and sometimes the traditional index comes out ahead. For example, from September 2019 to September 2021, the 10-year annualized total return for the S&P 500 EWI was 15.32%, whereas the S&P 500 outperformed with a 16.32% return.
Examples of Equal-Weight Funds
Invesco offers numerous equal-weight funds covering major indices like the S&P 500 and significant market sectors. The Invesco S&P 500 Equal Weight ETF (RSP), for instance, provides equivalent exposure to both the smallest companies and corporate giants such as General Electric within the S&P 500.
Due to the need for periodic rebalancing to maintain equal weighting, these index funds typically experience higher portfolio turnover than market-cap weighted funds, leading to larger trading costs and price volatility. However, they do offer a potential safeguard if a major sector suffers a downturn.
Other notable equal-weight index ETFs 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 tracks the NASDAQ-100 Equal Weighted Index.
Related Terms: market capitalization, exchange-traded funds, small-cap stocks, portfolio turnover, equal-weight indices.
References
- Yahoo Finance. “SPDR Dow Jones Industrial Average ETF Trust (DIA)”.
- S&P Dow Jones Indices. “S&P 500”.
- Invesco. “RSP—Invesco S&P 500® Equal Weight ETF”.
- Invesco. “Invesco Russell 1000 Equal Weight ETF”.
- First Trust. “First Trust NASDAQ-100 Equal Weighted Index Fund (QQEW)”.
