Abstract
Recent academic papers and practitioner publications suggest that equal-weighted portfolios (or 1/N portfolios) appear to outperform various other portfolio strategies. In addition, as the equal-weighted portfolio does not rely on expected average returns, it is therefore assumed to be more robust compared to other price-weighted or value-weighted strategies. In this paper, we provide a theoretical framework to the equal-weighed versus value-weighted equity portfolio model, and demonstrate using simulation as well as real-world data from 1926 to 2014 that an equal-weighted strategy indeed outperforms value-weighted strategies. Moreover, we demonstrate that a significant portion of the excess return is attributable to portfolio rebalancing. Finally, we show that because of equal-weighting, the excess returns are higher than the higher costs incurred due to higher portfolio turnover. Therefore, even after accounting for higher portfolio turnover costs, equal-weighting makes economic sense.
Similar content being viewed by others
References
Amenc, N., and Goltz, F. (2013) Smart Beta 2.0. Journal of Index Investing 4: 15–23.
Amenc, N., Goltz, F. and Martellini, L. (2011a) A Survey of alternative equity index strategies: A comment. Financial Analysts Journal 67: 14–16.
Amenc, N., Goltz, F., Martellini, L. and Retkowsky, P. (2011b) Efficient indexation: An alternative to cap-weighted indices. Journal of Investment Management, Fourth Quarter .
Arnott, R.D., Hsu, J. and Moore, P. (2005) Fundamental indexation. Financial Analysts Journal 61: 83–99.
Chow, T.-M., Hsu, J., Kalesnik, V. and Little, B. (2011) A survey of alternative equity index strategies. Financial Analysts Journal 67: 37–57.
DeMiguel, V., Garlappi, L. and Uppal, R. (2009) Optimal versus naive diversification: How inefficient is the 1/N portfolio strategy? Review of Financial Studies 22: 1915–1953.
Edelen, R., Evans, R. and Kadlec, G. (2013) Shedding light on invisible costs: Trading costs and mutual fund performance. Financial Analysts Journal 69.
Fama, E.F. (1970) Efficient capital markets: A review of theory and empirical work. Journal of Finance 25: 383–417.
Gibbons, M.R. (1982) Multivariate tests of financial models: A new approach. Journal of Financial Economics 10: 3–27.
Gruber, M.J. and Ross, S.A. (1978) The current status of the capital asset pricing model (CAPM). Journal of Finance 33: 885–901.
Lintner, J. (1965) The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Review of Economics and Statistics pp. 13–37.
Perold, A.F. and Sharpe, W.F. (1995) Dynamic strategies for asset allocation. Financial Analysts Journal 51: 149–160.
Plyakha, Y., Uppal, R. and Vilkov, G. (2014) Equal or value weighting? Implications for asset-pricing tests. SSRN, http://ssrn.com/abstract=1787045.
Plyakha, Y., Uppal, R. and Vilkov, G. (2015). Why do equal-weighted portfolios outperform value-weighted portfolios? SSRN, http://ssrn.com/abstract=2724535.
Roll, R. (1977) A critique of the asset pricing theory’s tests Part I: On past and potential testability of the theory. Journal of Financial Economics 4: 129–176.
Sharpe, W.F. (1964) Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance 19: 425–442.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Malladi, R., Fabozzi, F.J. Equal-weighted strategy: Why it outperforms value-weighted strategies? Theory and evidence. J Asset Manag 18, 188–208 (2017). https://doi.org/10.1057/s41260-016-0033-4
Revised:
Published:
Issue Date:
DOI: https://doi.org/10.1057/s41260-016-0033-4