The equal-weight method gives equal importance to each constituent in contrast to market-weighted investing, wherein the weight of each member is determined by the size. This is why during periods of volatility in bigger stocks, equal-weight indices outshine the benchmarks.
At times, an equal-weight strategy — where every stock in the index has the same weight, regardless of how large or small the company is — yields better results than a market cap-weighted one.
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A market cap strategy is where you end up owning more of the larger stocks because they have a greater weight in the index
In 2020 and 2021, the Nifty50 Equal Weight index beat the Nifty50 benchmark, which is a market capitalisation-weighted gauge.
Does that mean one has better chances of making money through stocks using an equal-weight strategy? Yes, sometimes.
"The equal-weighted index mode typically works well when there is high volatility in certain sectors, especially in index heavyweights. However, trying to time the investment in this mode is not ideal and should be followed more as a long-term investment strategy rather than a safe-haven during volatile times," Puneet Sharma, President of Funds at Whitespace Alpha, told CNBCTV18.com.
Does it fit your style?
"A market cap index follows momentum style (of investing) whereas equal-weight is more like value investing... It boils down to what exactly one is looking for. It basically comes down to which index can give the highest return on investment (RoI)," Prasanna Pathak, Acting CEO and Head of Equity at Taurus Mutual Fund, told CNBCTV18.com.
Equal-weigh style: How does it work?
The Nifty50 Equal Weight index, for instance, has 50 blue-chips — just as the parent index — but with a weightage of two percent each.
However, this makes a big difference in the overall weightage of sectors.
Choosing an equal-weight index fund over a regular one has its own merits and demerits. For starters, a regular index might take a bigger beating in times of violent moves in big stocks.
On the other hand, it may miss out on strength in heavyweights. That even as both track potentially the same stocks.
Why does this happen?
A matter of weight
This is why someone with a heavier allocation to certain stocks in a portfolio can have completely different results compared to others. And this is why wild moves in big stocks rewards or punishes different portfolios differently, even if if both have the same stocks in varying quantities.
"An equal-weight fund is more diversified than a market-weighted one as there is no undue concentration on any particular stocks or sectors," said Pathak of Taurus MF, who prefers an equal-weighted method for indices of top 100 and 200 companies by market cap.
When to — or whether at all — use the equal-weight method?
"The equal-weight method of investing is rarely practised. Since equal-weighted portfolios give equal importance to large, mid and small cap stocks, the risk is higher," VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services, told CNBCTV18.com.
"But one can consider an equal-weighted portfolio when large-caps are overvalued, and midcaps and small-caps are undervalued," he said.
All in all, one needs to keep two things in mind while considering the equal-weight style:
First Published: May 12, 2022 7:36 AM IST