Market Cap-Weighted Versus Equal-Weighted Indices


The U.S. equity market’s growth in 2023 has reminded us of the sometimes striking differences between “equal-weighted” and “market cap-weighted” indices. Market cap-weighted indices are those that vary position sizes based on the relative size of different companies. For example, Apple, a company valued at over $3 trillion, represents a much larger portion of the index than Ford, a company valued at around $50 billion. The most often referenced index in the world, the S&P 500 Index, is a market cap-weighted index.

An equal-weighted index, as the name implies, holds an equal amount of each company subject to periodic rebalancing. As investors, we can purchase either of these indices in a single exchange-traded fund (“ETF”) security (e.g., SPY for the S&P 500 market cap-weighted and RSP for the equal-weighted). Both of these indices will allow you to invest in the same companies, but in a dramatically different way.

So, which index is better? Well, these indices behave differently in different types of markets. When the equity market is rising, market cap-weighted indices tend to outperform. This occurs because the index effectively adds more of the top-performing stocks as they get larger. Thus, the index tends to capture large “momentum-driven” moves. In fact, this situation is exactly what we are seeing during 2023. The hottest stocks in 2023 are the “mega-cap” stocks (e.g., Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia and Tesla). As seen in the diagram below from Statista, most of the gain in 2023 is coming from these seven stocks—a stunning 84.3% of the total gain through June 7. 

By riding the momentum wave, the market cap-weighted S&P 500 index has handily outperformed its equal-weighted counterpart this year through August 11, 2023 (see chart below).

The problem with market cap-weighted indices is that momentum can go in both directions. Momentum tends to lead to “index concentration” (i.e., a small number of stocks make up an increasingly larger share of the index). Not surprising, this is exactly what has been happening in 2023 following a slight drop in 2022. As of August 2, 2023, the seven largest companies in the market cap-weighted S&P 500 Index make up over 27% of the index, while the other 494 companies make up the other 73%. Apple and Microsoft alone make up 14% of the index. Below is a chart showing how these seven stocks have become more and more concentrated as a percentage of the market cap-weighted S&P 500:

Another method to compare the S&P 500 market cap-weighted and equal-weighted versions is to look at equity sector exposures between the two. Below is the equity sector exposure of each (SPY on the top and RSP on the bottom) as of June 30, 2023. Given the high concentration of mega-cap technology in SPY, its largest sector is Information Technology with a weighting of 28.3%, whereas RSP only has a 13% weighting to the same sector. These charts show how RSP has a less concentrated exposure to some sectors and is arguably more diversified. 

Depending on the specific risk profile of the investor, portfolio construction can vary significantly from one investor to another. Therefore, it is important to know what is in your portfolio and what you are comparing your portfolio to when looking at trailing performance. Using the examples above, an investor owning SPY and RSP may have exposure to the same companies, but in a much different way. In regards to diversification, not many investors should have 27% of their portfolio invested in seven companies, and therefore comparing performance to the market cap-weighted S&P 500 Index is likely not a good comparison. Knowing how your portfolio is constructed can help an investor determine if they are exposed to the appropriate amount of risk or diversification. 


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