10 Years Later: Where in the World is Equal Weight Indexing Now?
by Liyu Zeng, Standard & Poor's
and Frank Luo, Standard & Poor's
via SSRN
Abstract:
Often the most powerful investment ideas are simple. The S&P 500 EWI 10 years ago pioneered the simple concept of equal weighted indexing. It has now expanded in the U.S. into the S&P 100, a MegaCap index, S&P MidCap 400® and S&P SmallCap 600®. The equal weighting idea has also been applied to international equities, as well as in other asset classes such as fixed income indices and commodity indices. It has become one of the most popular alternatively-weighted ideas. While the headline cause of asset flows has been outperformance over market-cap indices, sophisticated investors have realized that equal weighting creates a different set of risk factor exposures than market cap weighting that seem to have worked over the long-term as noted in the paper. Furthermore, the concept randomizes factor mispricings in the market, and it can serve as a performance benchmark for alternative-weighted indices.
April 20, 2013
Summary:
• The S&P 500® Equal Weight Index (EWI) was introduced in January 2003, pioneering the subsequent development of non-capitalization weighted indices, which have become the dominant theme of index innovation for the past decade.
• Equal weighing is factor indifferent. Because it randomizes factor mispricing, it is an attractive option for proponents of the theory that the market is inefficient and, at times, misprices factors.
• Equal weighting represents a choice of portfolio construction in which the constituent weightings are not correlated with their expected returns. Consequently, an equal-weight index can serve as the performance benchmark for all alternative-weighted indices.
• The S&P Equal Weight Indices have different properties from their underlying headline indices, including a lower concentration of individual stocks and slower-changing sector exposures.
• Historically, the S&P Equal Weight Indices have outperformed their market capitalization (market cap) weighted equivalents over longer time periods. The level of outperformance has also varied considerably under different market conditions.
• The outperformance of the S&P Equal Weight Indices results from differing weighting and rebalancing processes. In terms of risk factor exposure, a complex and dynamic combination of size and style risk factors have contributed to return differences. It may be difficult to replicate the equal weight index return outcomes through a simplistic combination of style and sector indices.
• Equal weighting has also demonstrated long-term outperformance internationally.
• Criticism of equal weight indices has centered on increased turnover and capacity constraints relative to market-cap weighted indices. While true in abstract theory, neither is a serious hurdle in practice.
Read the whole paper in the slidedeck below or download it:
10 Years Later: Where in the World is Equal Weight Indexing Now?
