Equal vs. Value and Price-Weighted Portfolios: Who Wins?

Equal-weighted portfolio of stocks in the major US equity indices with monthly rebalancing outperforms value- and price-weighted portfolios, a new report claims. 

(March 28, 2012) — “Why does an equal-weighted portfolio outperform value- and price-weighted portfolios?,” asks a newly released report. 

According to the authors — Yuliya Plyakha and Grigory Vilkov of the Goethe University of Frankfurt and Raman Uppal from the EDHEC Business School  —  the higher systematic return of the equal-weighted portfolio comes from its higher exposure to the market, size, and value factors. The report continues: “The higher alpha of the equal-weighted portfolio arises from the monthly rebalancing required to maintain equal weights, which is a contrarian strategy that exploits reversal and idiosyncratic volatility of the stock returns; thus, alpha depends only on the monthly rebalancing and not on the choice of initial weights.”

The report compares the performance of equal-, value-, and price-weighted portfolios of stocks in the major US equity indices over the last four decades. While an equal-weighted portfolio has greater portfolio risk, the report asserts that equal-weighted portfolios with monthly rebalancing outperform value- and price-weighted portfolios in terms of total mean return, four factor alpha, Sharpe ratio, and certainty-equivalent return. 

“The total return of the equal-weighted portfolio exceeds that of the value- and price-weighted because the equal-weighted portfolio has both a higher return for bearing systematic risk and a higher alpha measured,” the report says. However, the equal-weighted portfolio has a higher volatility (standard deviation) and kurtosis compared to the value- and price-weighted portfolios. 

The conclusion: “The results…imply that the source of the superior performance of the equal- weighted portfolio is its significantly higher mean return, along with its less-negatively skewed returns.” 

To complete the analysis, the authors constructed equal-, value-, and price-weighted portfolios from 100 stocks randomly selected from the constituents of the S&P500 index over the last 40 years. 

Click here to download the full report.