Decoding the rationale of equal weight investing
Investor interest in the markets has been on the rise ever since the covid pandemic drove people indoors during the lockdowns. Many individuals have since been drawn to the alpha returns generated from market investments, particularly in mutual funds. That, in turn, has prompted fund managers to craft strategies delivering the best returns.
This story deals with one such strategy—equal weight investing—and what it means to create and manage your fund portfolio. The conventional approach to index construction for a portfolio relies on market capitalization for weightage of stocks. However, the emergence of ‘smart beta’ strategies that seek to passively follow the indices have introduced a subset of strategies.
These include equal weight investing, which assigns equal weights to all components in an index. This deviation has both pros and cons, as observed in the case of the Nifty 50 Equal Weight Index (EWI) and the Nifty 50 Index. The EWI offers a more diversified and less concentrated portfolio, reducing the risk associated with dominant companies.
Additionally, it tends to have a lower price-to-earnings (P-E) ratio, potentially making it attractive for long-term investors. The main difference lies in the allocation methodology between Nifty 50 and Nifty 50 EWI. The traditional Nifty 50 Index tends to be skewed towards heavyweight stocks, where the top 5 stocks contribute significantly to most of the portfolio.
The Nifty 50 EWI allocates an equal 2% weight to each stock, irrespective of its market capitalization. This approach ensures more balanced exposure, mitigating the concentration risk posed by a few dominant companies. “For instance, consider that we have a 4 stock fund with 25% weightage each for HDFC Bank, ICICU
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