S&P Dow Jones Indices has published a research paper on equally weighted indices as benchmark.
Tim Edwards, director of Index Investment Strategy and Craig Lazzara, senior director Index Investment Strategy. Analysed whether equal weight benchmarks are better than cap-weighted benchmarks when evaluating active managers.
Specifically, they make the case for equally weighted indices as complementary benchmarks, particularly in periods of decidedly different performance from their capitalization-weighted counterparts.
According to Edwards and Lazzara, comparing the performance of strategies or managers to equal weight benchmarks indicated if a strategy is truly adding value or is no better than blind luck.
The research argues that equal weight indices have outperformed their cap-weighted counterparts for several decades in the US and Europe, suggesting advantages to both “alternative beta” and “stock-picking” strategies.
The former advantage has been realized in outperformance, the latter not so much: it seems the average manager tilts towards equal weighting only to a small degree and charges significant fees to boot. The researchers argue that for many active strategies, equal weight benchmarks are more appropriate and informative, and “harder to beat.”
According to Tim Edwards, “Equal weighting wasn’t smart in itself, but its success had the effect of making some alternatively weighted strategies look smart.”
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