Equal-Weighted Indexing
Proponents of equal weighting say their strategy limits the damage any single stock can have on the underlying index. For example, Apple and Exxon each represent ~3% of the S&P 500, while GE and Chevron each account for < 2%. The 10 largest S&P 500 companies account for close to 20% of the value of the entire index. Under the S&P 500 Equal Weight Index, all 500 companies each represent exactly 0.2% at all times; the 10 largest companies would have a combined weighting of 2.0% (0.2% ×10).
Those who support an equal-weighted approach point out that the vast majority of indexes are capitalization weighted and thus have a “buy high and sell low” approach. When the bigger stocks are doing well, investors in these indexes are taking advantage of the gains; when they tumble, these same investors suffer more than those investing in an equal-weighted index.
There are shortcomings to an equal-weighted index: [1] quarterly rebalancing means a higher turnover and less tax efficiency as winners are sold off and positions in the previous quarter’s losers are increased; [2] this contrarian approach means the strategy tends to favor value stocks—something that has proven itself historically, but still a strategy not favored by everyone; [3] equal weighting of many indexes means a greater weighting in mid and small cap issues, resulting in larger performance swings—this can be a plus or a minus (e.g., in 2008, the S&P 500 lost 37%, while its equally weighted brethren dropped 40%; in 2009, the equal-weighted index gained 45%, while the cap-weighted S&P 500 was up 26%); and [4] a cap-weighted fund is likely to have a much lower expense ratio than its equally weighted counterpart.
