Skip to main content

Equal-weighted strategy: Why it outperforms value-weighted strategies? Theory and evidence

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.

This is a preview of subscription content, access via your institution.

Figure 1
Figure 2
Figure 3
Figure 4
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
Figure 13
Figure 14
Figure 15

References

  • Amenc, N., and Goltz, F. (2013) Smart Beta 2.0. Journal of Index Investing 4: 15–23.

    Article  Google Scholar 

  • Amenc, N., Goltz, F. and Martellini, L. (2011a) A Survey of alternative equity index strategies: A comment. Financial Analysts Journal 67: 14–16.

    Article  Google Scholar 

  • 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.

    Article  Google Scholar 

  • Chow, T.-M., Hsu, J., Kalesnik, V. and Little, B. (2011) A survey of alternative equity index strategies. Financial Analysts Journal 67: 37–57.

    Article  Google Scholar 

  • 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.

    Article  Google Scholar 

  • 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.

    Article  Google Scholar 

  • Gibbons, M.R. (1982) Multivariate tests of financial models: A new approach. Journal of Financial Economics 10: 3–27.

    Article  Google Scholar 

  • Gruber, M.J. and Ross, S.A. (1978) The current status of the capital asset pricing model (CAPM). Journal of Finance 33: 885–901.

    Article  Google Scholar 

  • 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.

    Article  Google Scholar 

  • 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.

    Article  Google Scholar 

  • Sharpe, W.F. (1964) Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance 19: 425–442.

    Google Scholar 

Download references

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Rama Malladi.

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

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

Download citation

  • Revised:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1057/s41260-016-0033-4

Keywords

  • equal-weighted
  • cap-weighted
  • 1/N
  • asset allocation
  • portfolio optimization

JEL Classification

  • G11