In the latest edition of Wealthtrack with Consuelo Mack, risk expert Richard Bookstaber says he prefers equal weighted indices over capitalization weighted indices at this moment.
An equal weighted index doesn’t rank stocks according to their overall market value or market capitalization; instead, it weights them equally. In other words, it breaks the link between market value and index weighting. It serves as a contrarian approach by lowering the weightings of the stocks with the highest market values, and elevating the weightings of the stocks with the lowest market values.
For example, instead of being more than 7% of a capitalization weighted index like the S&P 500, Apple becomes 0.20% (or one-five-hundredth) of the S&P 500 Equal Weighted Index (as do the other 499 stocks).
I wrote about how much the plain S&P 500 has outperformed its equal weight version in my last blog post. For the first five months of this year, the S&P 500 has outperformed its equal weight counterpart by more than 10 percentage points, more than for any other rolling (by month) five-month period for the past two decades. While nobody can be certain, and while the companies at the top of the plain S&P 500 are exceedingly profitable, it’s reasonable to be suspicious that such outperformance can continue.
An equal weighted index arguably counters the sociability of human beings which encourages us to own more of what everyone seems to love and has vaulted to the top of a capitalization weighted index.
Unfortunately, our inherent sociability is often counter-productive in investing.
