Investors who are seeking to build out a diversified long-term investment portfolio should consider enhancing returns through equally weighted exchange traded funds.
Researchers led by Timo Pfeiffer, Head of Research & Business Development at Solactive, found that equally weighted portfolios outperform market cap weighted ones over a period of evaluation running from 2000 to 2017, falling more during bear markets but recovering faster after downturns, according to a recent Solactive AG research paper.
“Our study shows that the most important driver of the equally weighted portfolio’s outperformance is the higher exposure to small cap stocks. Therefore, although stock size is not taken into consideration with equally weighted strategies, it is actually the most important factor in explaining their outperformance over market cap weighted portfolios,” according to Solactive AG.
Over the test period of February 2000 through October 2017, equally weighted portfolios outperformed market-cap weighted indices, exhibiting higher systematic risk but a faster recovery time. In other words, while equally weighted indices may exhibit greater risk during drawdowns, they were faster to recover and outperform in rebounding conditions.
The researchers found that equally weighted portfolios provide better diversification and diminish unsystematic risk or lower overall concentration risk in a traditional market cap-weighted investment portfolio. This makes sense since equally weighted indices and related ETFs generally lean toward mid- and small-cap companies.