When Size Doesn’t Matter: Equal Weighting versus Market Cap Weighting
When Size Doesn’t Matter: Equal Weighting vs Market Cap Weighting provides a detailed overview of the equal weighting method, comparing this to the more traditional market cap weighting scheme. In the former case, all securities are weighted equally, regardless of their market capitalization, whereas in the latter one, securities are weighted proportionally to their market capitalization.
The paper finds that equally weighted portfolios outperform market cap weighted ones over a period of evaluation running from 2000 to 2017, falling more during bear markets, but recovering faster after downturns.
The study also shows that the most important driver of the equally weighted portfolio’s outperformance is the higher exposure to small cap stocks. Therefore, although stock size is not taken into consideration with equally weighted strategies, it is actually the most important factor in explaining their outperformance over market cap weighted portfolios.
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