After peaks in S&P 500 concentration, the S&P 500 Equal Weight Index has tended to outperform.
Using the historical adjusted HHI (Herfindahl-Hirschman Index), a statistical measure of concentration has determined that concentration tends to mean-revert in most sectors, according to Anu Ganti, senior director, index investment strategy, S&P Dow Jones Indices.
“Changes in concentration affect the relative performance of the equal-weighted versions of each sector. Equal-weighted sectors tend to outperform after peaks in their sector concentration. This is particularly noticeable for Information Technology,” Ganti wrote.
Since information technology and consumer discretionary’s adjusted HHIs are at historically high levels, equal weighting within these sectors rather than cap weighting them might be worth considering, since concentration tends to mean-revert over time, according to Ganti.
The S&P 500 Equal Weight Index outperformed the S&P 500 by 2% in Q1, according to S&P Dow Jones Indices U.S. Equal Weight Sector Dashboard.
The simple arithmetic of rebalancing connects equally weighted indexes to momentum effects. If the price of a constituent increases by more than the average of its peers, then its weight in the portfolio will increase, and the position will necessarily be trimmed at the next rebalance as the portfolio returns to equal weights, according to S&P Dow Jones Indices.
On the other hand, if a stock falls by more than the average of its peers, its weighting will fall too — and more must be purchased at the next rebalance to return to equal weight. Thus, equal-weight indexes sell relative winners and purchase relative losers at each rebalance.
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