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Equal-weighted strategy: Why it outperforms value-weighted strategies? Theory and evidence

Author

Listed:
  • Rama Malladi

    (Kubera Investments LLC)

  • Frank J. Fabozzi

    (EDHEC Business School)

Abstract

Recent academic papers and practitioner publications suggest that equal-weighted portfolios (or 1/N portfolios) appear to outperform various other portfolio strategies. In addition, as the equal-weighted portfolio does not rely on expected average returns, it is therefore assumed to be more robust compared to other price-weighted or value-weighted strategies. In this paper, we provide a theoretical framework to the equal-weighed versus value-weighted equity portfolio model, and demonstrate using simulation as well as real-world data from 1926 to 2014 that an equal-weighted strategy indeed outperforms value-weighted strategies. Moreover, we demonstrate that a significant portion of the excess return is attributable to portfolio rebalancing. Finally, we show that because of equal-weighting, the excess returns are higher than the higher costs incurred due to higher portfolio turnover. Therefore, even after accounting for higher portfolio turnover costs, equal-weighting makes economic sense.

Suggested Citation

  • Rama Malladi & Frank J. Fabozzi, 2017. "Equal-weighted strategy: Why it outperforms value-weighted strategies? Theory and evidence," Journal of Asset Management, Palgrave Macmillan, vol. 18(3), pages 188-208, May.
    • Handle: RePEc:pal:assmgt:v:18:y:2017:i:3:d:10.1057_s41260-016-0033-4
    DOI: 10.1057/s41260-016-0033-4
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    References listed on IDEAS

    as
    1. Ross, Stephen A, 1978. "The Current Status of the Capital Asset Pricing Model (CAPM)," Journal of Finance, American Finance Association, vol. 33(3), pages 885-901, June.
    2. Victor DeMiguel & Lorenzo Garlappi & Raman Uppal, 2009. "Optimal Versus Naive Diversification: How Inefficient is the 1-N Portfolio Strategy?," The Review of Financial Studies, Society for Financial Studies, vol. 22(5), pages 1915-1953, May.
    3. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    4. Gibbons, Michael R., 1982. "Multivariate tests of financial models : A new approach," Journal of Financial Economics, Elsevier, vol. 10(1), pages 3-27, March.
    5. Roll, Richard, 1977. "A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory," Journal of Financial Economics, Elsevier, vol. 4(2), pages 129-176, March.
    6. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
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    Cited by:

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    2. Steven Campbell & Qien Song & Ting-Kam Leonard Wong, 2024. "Macroscopic properties of equity markets: stylized facts and portfolio performance," Papers 2409.10859, arXiv.org, revised Oct 2024.
    3. Amit Pandey & Anil Kumar Sharma, 2023. "Effect of Index Concentration on Index Volatility and Performance," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 30(3), pages 559-585, September.
    4. Ngo, Vu Minh & Nguyen, Huan Huu & Van Nguyen, Phuc, 2023. "Does reinforcement learning outperform deep learning and traditional portfolio optimization models in frontier and developed financial markets?," Research in International Business and Finance, Elsevier, vol. 65(C).
    5. C. N. V. Krishnan & Minghao Wu, 2022. "The Methodology Matters: What Influences Market Reaction, and Post-Issue Returns in Seasoned Equity Offerings?," JRFM, MDPI, vol. 15(10), pages 1-22, October.

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    More about this item

    Keywords

    equal-weighted; cap-weighted; 1/N; asset allocation; portfolio optimization;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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