essays pieces of the puzzle
Tuesday, March 29th, 2011
weight watching

The bulk of assets in passive strategies are invested according to indexes that are market-weighted.  However, those portfolios have badly lagged their equal-weighted counterparts since the dawn of the year 2000, as is shown by the respective series for the S&P 500.

While the equal-weighted variety showed that it didn’t deal well with the trauma of the financial crisis, its stunning drawdown at that time has been matched by an equally remarkable bounce off of the bottom.  Given the gap in the results for the two and the tendency for investors to chase returns, it’s likely that equal weighting has been gaining adherents data point by data point.  It might even be that some active managers have grown comfortable straying further from their market-weighted benchmarks than they normally do.

At some point, however, this trade will flip back in a major way and the market-weighted indexes will be formidable competitors.  Will it only be when the market corrects?  We know from the 1990s that that doesn’t have to be the case — the biggest stocks can lead in an up market.  But whatever the cause of the change, should the behemoths that have been lagging get traction, it will cause significant disruption in a pattern that has gotten pretty comfortable.  (Chart:  Bloomberg terminal.)