Equal Weight or Market Weight ?

July 3, 2024 3 min read

Comparing S&P 500 and Equal Weighted Index

Let us first understand the difference between the regular S&P 500 index and the equal weighted S&P 500 index. The regular S&P 500 index is weighted by market capitalization, meaning that larger companies have a more significant impact on the index. In contrast, the equal weighted index treats all 500 stocks equally. Over the past two and a half years, the regular S&P 500 index has increased by about 17%, while the equal weighted index has only increased by about 2%. This difference shows that the larger, more heavily weighted stocks in the S&P 500 are performing much better than the smaller stocks.

The Performance Gap

The large gap between the regular S&P 500 index and the equal weighted index indicates that the big, heavyweight stocks are driving the market’s performance. Smaller stocks, on the other hand, are not doing as well. This trend shows the significant influence that a few big companies have on the overall market. In the case of the S&P 500, if the larger companies do well, the index does well, even if the smaller companies do not perform as strongly.

India’s Market: A Different Story

In India, the situation is quite different. When comparing the regular Nifty index to the equal weighted Nifty index over the same period, the equal weighted index has performed much better. Since January 2022, the regular Nifty index has returned about 36%, while the equal weighted Nifty index has returned about 56%. This suggests that the smaller, less heavily weighted stocks in the Nifty index are performing better than the larger, more heavily weighted stocks.

Heavyweights Underperforming in India

The performance of the equal weighted Nifty index indicates that the heavyweight stocks in the Nifty index are not doing well. Companies like ITC, Nestle, Bajaj Finance, Asian Paints, and Hindustan Unilever, which have significant weights in the Nifty index, have not performed as well as some of the smaller stocks. In contrast, stocks like Bajaj Auto and Coal India, which have lower weights in the index, have been performing exceptionally well.

Impact of Market Rebalance

Over time, the weights of stocks in the Nifty index will adjust during rebalancing. If the current trend continues, the weights of the better-performing stocks will increase, while the weights of the underperforming stocks will decrease. However, this adjustment takes time. Investors in the Nifty index might miss out on the strong performance of smaller stocks if they are heavily invested in the larger, underperforming stocks.

Investment strategies that are not tied to the Nifty index weights can benefit from the strong performance of smaller stocks. For example, a strategy that gives equal weight to the top-performing stocks in the Nifty index can outperform the regular Nifty index. This is because it does not rely heavily on the weights of the larger, underperforming stocks. For instance, if a strategy equally weights the top ten performers, it can achieve better returns by avoiding the drag of the larger, non-performing stocks.

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    Equal Weight or Market Weight ?