Equal weighting is the oldest of alternative weighting methods and it has had staying power for good reason. We explore the attributes of equal weighting and explore FTSE Russell’s enhanced methodology, which has an added benefit over simple constituent equal weighting by enhancing sector diversification.
There is growing interest in alternative weighting methods which seek to reduce concentration. Concentration risk can arise when a handful of large mega cap stocks or a minority of sectors come to dominate standard market cap weighted indexes. Equal weighting is the oldest of these alternative weighting methods and it has had staying power for good reason.1 The Russell 1000® Equal Weight Index had less drawdown during both the dotcom bust and global financial crisis with shorter times to full recovery than its cap weighted counterpart, as we show in this paper. In this Insights we will explore the attributes of equal weighting and explore FTSE Russell’s enhanced methodology, which has an added benefit over simple constituent equal weighting by enhancing sector diversification.
Why equal weighting?
Many investors utilize products that replicate market cap indexes in their portfolios. Low cost, transparency, and exposure to a large number of stocks are among the benefits of such a passive approach. But there may be less diversification in this approach than first meets the eye, as many cap weighted and sector indexes are dominated by mega cap stocks and a few heavily weighted sectors. Often, as go the mega caps, so goes the performance of the whole index. This concentration risk means that a cap weighted index actually may provide the diversification equivalence of only a fraction of the number of stocks in the index, as we will show. Moreover, by reducing the impact of mega caps, an equal weighted approach shifts exposures down to midcap stocks. Midcap stocks may provide an additional layer of diversification as they can have different return patterns from mega caps. Midcaps are where some of the most innovative companies can be found. Some of them may be the mega caps of tomorrow, providing the investor with upside return potential.
Read the complete white paper at the link beneath Related Files