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Performance of Equal Weighted Indices
Many studies have shown that equal weighted indices outperform their market cap weighted equivalents in the long run. A research paper published by Standard and Poor’s in July 2010 using back-tested data shows that the S&P 500 Equal Weight Index (EWI) would have outperformed the S&P 500 index by 1.8% per annum over the last 20 years. However, the level of performance would have varied considerably over time in line with different market cycles. The S&P 500 EWI would have outperformed in the early 1990s but would have lagged the S&P 500 for six straight years from 1994 through 1999, significantly underperforming during the technology bubble of the late 1990s. Then, the S&P 500 EWI would have beaten the S&P 500 for seven consecutive years through 2006 and lagged again during the financial 2007-2008 crisis.
Unfortunately, in the case of the indices tracked by the ThinkCapital and Ossiam products, we are not able to collect the same amount of data to go as far back in time as the S&P study. But based on the data available, we have conducted our analysis on the five equal weighted indices used by Ossiam and ThinkCapital since 2002 and 2007 respectively. In line with the common belief that mid- and small-caps fare better during bull markets (typically in periods following recessions) and underperform during bear markets, four out of the five indices underperformed during the 2007-2008 financial crisis and all outperformed during the 2009 rebound.
Also, the backtest shows that the EURO STOXX 50 EWI would have outperformed the EURO STOXX 50 by 2% annually since 2002, while the STOXX Europe 600 EWI would have lagged its market cap weighted equivalent by 0.2%. These results can be explained by the inferior performance of mid- and small- stocks relative to large stocks in Europe for five straight years from 2004 through 2008. However, following the 2007-2008 financial crisis, the significant rebound in mid- and small caps benefited the STOXX Europe 600 EWI more than the EURO STOXX EWI, again because of the small-cap bias inherent in the former.
Back-tested data since 2005 also reveals that the CAC 40 EWI would have beaten its headline index by an impressive 4.6% per year, significantly outperforming during the 2009 equity market rally. This would have been partly attributed to the difference in sector weights between the two indices. The CAC 40 EWI has been overweight certain sectors such as financials and consumer goods, and underweight other sectors, such as oil & gas and healthcare.
Equally, the Think Global Equity would have outperformed the MSCI World by 1.4% over the past 4 years, while the Think Real Estate Coverage index would have underperformed the MSCI World Real Estate index by 2.3%. Again, this difference in performance can be explained by the Think Real Estate fund’s tilt towards mid- and small- caps. As expected, the index lagged its headline index during the 2007-2008 financial crisis, but bounced back sharply in 2009.
Conclusion
With the recent launch of ThinkCapital and Ossiam’s equal weighted ETFs, European investors are discovering a new equity indexing strategy which some consider more rational than the traditional market cap weighting approach because of the more diversified exposure it offers. A wealth of studies has been published on equal weighted indices, investigating their potential to provide excess performance against their market cap equivalents in the long run. While the issue is still being debated, investors should keep in mind that the two indexing methodologies provide a different set of risk factor exposures, resulting in different returns. In addition, they should be mindful of performance comparison results which always exhibit high dependency on period and equity basket selected.
