Equal Weights
An equally weighted portfolio (EWP) is an investment strategy that allocates the same proportion of capital to each asset in the portfolio, regardless of its market capitalization. This approach contrasts with market-capitalization-weighted (MCW) portfolios, which allocate capital to each asset based on its size.
How an Equally Weighted Portfolio Works
In an EWP, each asset is assigned an equal weight, typically expressed as a percentage of the total portfolio value. For instance, if an EWP consists of 10 assets, each asset would be allocated 10% of the portfolio's total value. This means that the performance of each asset has an equal impact on the overall performance of the portfolio.
Benefits of an Equally Weighted Portfolio
- Diversification: EWP promotes diversification by giving smaller and mid-cap stocks a larger role in the portfolio compared to their representation in the market. This can help reduce portfolio concentration and potentially lower overall risk.
- Rebalancing Discipline: EWP inherently incorporates a rebalancing strategy, as the portfolio's weights are adjusted back to their equal targets periodically. This helps maintain the desired asset allocation and prevents the portfolio from becoming overly concentrated in certain asset classes.
- Potential for Outperformance: Studies have shown that EWP can outperform MCW portfolios over the long term, particularly during periods when smaller and mid-cap stocks outperform larger-cap stocks.
Considerations for an Equally Weighted Portfolio
- Increased Volatility: EWP may experience higher volatility than MCW portfolios, as smaller and mid-cap stocks tend to be more volatile than larger-cap stocks.
- Higher Liquidity Risk: Since EWP gives equal weights to small caps, liquidity risk is increased as such instruments have usually a larger bid-ask spread, resulting in additional costs when buying or selling them.