Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 508

Why equal weighting resolves Australian index skews

An equal weighting investment strategy is different from traditional market capitalisation approaches. Equal weighting, as the names suggests, treats all the companies the same, equally weighting them so big swings in one company can’t skew the index.

By way of contrast, in market capitalisation indexes, companies which make up the index are included in amounts that correlate to their total market capitalisation. The bigger the company, the bigger the proportion it represents of the index.

Most of the equity indexes quoted in the media are market capitalisation indexes, for example, the S&P/ASX 200 Index is a market capitalisation index. Moreover, the S&P/ASX 200 index is one of the most concentrated sharemarket indexes in the world. The largest 10 companies represent over 45% of the index.

This means that big-company constituents can shift the index more than little ones. This is great when those big companies are on the way up, but not so great when they are on the way down or have limited potential for growth.

Equal weighting offers an alternative method to investors and they have historically outperformed their market capitalisation counterparts over the long term. The following chart demonstrates this, though we always caution, past performance cannot be relied upon for future performance.

This chart shows the performance of Australia’s standard equal weighted index, the MVIS Australia Equal Weight Index against Australia’s standard market capitalisation weighted index, the S&P/ASX 200 Index (S&P/ASX 200).

In various studies it has been shown that equal weighting performs well because of the following reasons:

  1. Higher exposure to smaller stocks rather than larger stocks
  2. Higher exposure to so-called ‘value stocks’ meaning those stocks with a high book-to-market ratio, and
  3. Better market timing as equal weighting extracts more returns when markets are rising and loses less when markets are falling.

1. Higher exposure to smaller stocks

An equal weight approach provides greater diversification by reducing concentration risk both at an individual stock level and a sector level.

A mathematical analysis demonstrated that equal weighting outperformed because of its greater exposure to smaller stocks, which outperform larger stocks. The word ‘smaller’ was used in the analysis with its precise meaning as a relative term. There was no suggestion that the stocks referred to in the paper were small aps. Rather, these are stocks smaller than those mega-caps who, because of their size, dominate market capitalisation indices. 

The mathematical analysis in Why Equal Weighting Outperforms: The Mathematical Explanation showed that the returns from the larger caps are more narrowly distributed than their ‘smaller’ peers so never deliver the very high returns that will be generated by some of the smaller stocks (the paper uses the top 12 to represent the ‘larger’ stocks). You can see this in the figure below, taken from the paper.

We recently highlighted how this is relevant during periods of market recoveries in The road to recovery (revisited): Further analysis of equal weight performance after market declines.

2. Higher exposure to value stocks

Rebalancing an equal-weight index also injects a mild value tilt into the portfolio. In order to maintain its desired weights, the strategy will sell shares that have appreciated relative to their target weight and use the proceeds to buy those that have declined since the previous rebalance.

By assigning the same weight to each constituent, the equal weight index is simply tilting toward stocks with smaller market capitalisations and lower valuations, which have historically outperformed their larger and more expensive counterparts. Mechanically shifting assets away from companies that have become more expensive and toward those that are now cheaper can be an advantage when the market’s valuation reaches extremes (either too expensive or too cheap).

According to research from Plyakha, Uppal and Vilkov[1] the higher systematic return of the equal-weighted portfolio arises from its higher exposure to the market, size, and value factors.

3. Better market timing

Research by Lajbcygier, Chen and Dempsey (2015)[2] analysing US data over a period of nearly 50 years found that equal-weighted indexing had a statistically significant positive bi coefficient, meaning that it is able to systematically ‘time’ the market by outperforming in down markets. 

In Australia, the universe of companies is too small and too concentrated and there is a lack of variability over time. A concentrated market limits stock diversification and means investors potentially overlook the stronger opportunities among smaller companies.

Equal weighting offers investors a strategy that has historically outperformed market-capitalisation indexes over the long-term. The choice to equally weight also helps risk management and better diversify, avoiding overexposure to any single name.

 

Cameron McCormack is a Portfolio Manager at VanEck Investments Limited, a sponsor of Firstlinks. This is general information only and does not take into account any person’s financial objectives, situation or needs. Any views expressed are opinions of the author at the time of writing and is not a recommendation to act.

For more articles and papers from VanEck, click here.

 

[1] Why Does and Equal-Weighted Portfolio Outperform Value- and Price Weighted Portfolios?, Plyakha, Raman Uppal and Grigory Vilkov January 31 2012

[2] Lajbcygier, Paul & Jeremy Sojka, 2015, “The viability of alternative indexation when including all costs” CSIRO Monash Superannuation Research Cluster, Working paper series

 

  •   10 May 2023
  • 5
  •      
  •   

RELATED ARTICLES

ASX200 'handbrake' means passive investors could miss out

CBA and the index conundrum for super funds

Are markets broken?

banner

Most viewed in recent weeks

Warren Buffett's final lesson

I’ve long seen Buffett as a flawed genius: a great investor though a man with shortcomings. With his final letter to Berkshire shareholders, I reflect on how my views of Buffett have changed and the legacy he leaves.

The housing market is heading into choppy waters

With rates on hold and housing demand strong, lenders are pushing boundaries. As risky products return, borrowers should be cautious and not let clever marketing cloud their judgment.

Why it’s time to ditch the retirement journey

Retirement isn’t a clean financial arc. Income shocks, health costs and family pressures hit at random, exposing the limits of age-based planning and the myth of a predictable “retirement journey".

Australia's retirement system works brilliantly for some - but not all

The superannuation system has succeeded brilliantly at what it was designed to do: accumulate wealth during working lives. The next challenge is meeting members’ diverse needs in retirement. 

The 3 biggest residential property myths

I am a professional real estate investor who hears a lot of opinions rather than facts from so-called experts on the topic of property. Here are the largest myths when it comes to Australia’s biggest asset class.

Australian stocks will crush housing over the next decade, 2025 edition

Two years ago, I wrote an article suggesting that the odds favoured ASX shares easily outperforming residential property over the next decade. Here’s an update on where things stand today.

Latest Updates

Investment strategies

Australian stocks will crush housing over the next decade, 2025 edition

Two years ago, I wrote an article suggesting that the odds favoured ASX shares easily outperforming residential property over the next decade. Here’s an update on where things stand today.

Property versus shares - a practical guide for investors

I’ve been comparing property and shares for decades and while both have their place, the differences are stark. When tax, costs, and liquidity are weighed, property looks less compelling than its reputation suggests.

Investment strategies

What if Trump is right?

Trump may be right on two trends: nations are shifting from aspiration to essentials and from global dependence to self-reliance, pushing capital toward security, infrastructure, and energy.

Gold

After a stellar 2025, can gold shine again next year?

Gold has had a remarkable 2025, with the spot price likely to post its strongest return since 1971. This explores the key factors that will shape the outlook for the yellow metal next year, and long-term.

Superannuation

Critics of Commonwealth defined benefit schemes have it wrong

Critics like Clime's John Abernethy have questioned many aspects of defined benefit pensions for public servants. This is an attempted rebuttal, suggesting these pensions aren't the problem they're made out to be.

Infrastructure

Why airport stocks deserve a place in long-term portfolios

Aircraft constraints are holding back global air travel. Those constraints should soon ease which combined with a structural boom in travel demand could be a boon for global airport stocks.

Investment strategies

What is the future of search in the age of AI?

Search is changing fast. AI tools like ChatGPT and Google’s Gemini are reshaping how we find information, opening new opportunities for innovation, user engagement, and future revenue growth.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.