Equal weight investing in the S&P 500 index has gained popularity over recent years. By assigning equal weights to all S&P 500 constituents, it aims to provide more stable returns and better diversification compared to market capitalization weighted S&P 500 index. In this article, we will analyze the rationale, performance, and risks of equal weight S&P 500 strategies.
Theoretical basis of equal weighting
The idea behind equal weighting is that market cap weighted indexes tend to concentrate positions in a few large companies, making the index return dependent on just those companies. By contrast, equal weighting reduces concentration risk and provides exposure to the broad market. Some studies have found that equal weighting historically earned higher returns with lower volatility versus market cap weighting.
Empirical performance of equal weight S&P 500
Various empirical studies have analyzed the historical performance of equal weight S&P 500 strategies. Over the past couple decades, equal weight S&P 500 delivered higher annualized returns of 2-3% above the market cap S&P 500, along with lower volatility. The outperformance is partly attributed to the value and size tilts of equal weighting.
Potential risks and implementation costs
However, equal weighting also has some risks to consider. It tends to overweight smaller, more volatile stocks which could underperform in certain environments. There are higher rebalancing costs as the portfolio is rebalanced periodically to maintain equal weights. For individual investors, the costs and tracking error challenges makes ETFs a more practical option over self-indexing.
In summary, equal weight investing provides diversification benefits versus market cap weighted S&P 500 exposure, and has historically earned higher risk-adjusted returns. But the outperformance may not persist, while rebalancing costs and exposure risks should be evaluated.