Among the many and varied smart beta index strategies that have emerged over the past decade, equal weight indexes were the earliest and arguably the least complex. With the objective of breaking the link between a stock’s price and its weight in the index, some of the first equal weight indexes took the simple approach of equally weighting all constituents. But this meant that the weight of each sector was determined solely by the number of companies in the sector, which could result in significant sector biases.
The Russell Equal Weight Index series methodology seeks to solve this problem by first of all equal weighting the sectors and then equal weighting the companies within each sector. As a result, the Russell 1000 Equal Weight Index—the US large cap index within the series—reflects the largest securities in the US equity market while maintaining diversification across sector groups.
A comparison of sector weights highlights how this equal-weighted approach can result in material differences from comparable cap-weighted indexes. As illustrated below, sector allocations as of last quarter end varied considerably between the Russell 1000 and Russell 1000 Equal Weight Index.
Source: Russell as of March 31, 2015. Past performance is no guarantee of future results.
Although sector exposures differed, data suggests that a key driver of year-to-date performance differences has not been the sector weights but rather how securities are weighted within each sector. This is evident when comparing the differences in sector returns for the year-to-date period ending April 30.
Source: Russell as of April 30, 2015. Past performance is no guarantee of future results.
The above data demonstrates that weighting the securities equally within each sector resulted in higher performance for several sectors. Most notably, the Health Care sector return for the Russell 1000 Equal Weighted Index exceeded that of the Russell 1000 by 3.5%, and for the Energy sector the differential was 8.2%.
A key contributor to strong relative performance for the Russell 1000 Equal Weight Index has been the size factor. Because the index spreads exposures evenly across the opportunity set, it avoids the concentration that can occur in market cap-weighted indexes where a few large companies can dominate index performance simply because of their size. That concentration can skew index results either positively or negatively.
Such data underscores how index composition differences can lead to a significant divergence in performance, and how equal weighting on both a sector and security level can at times affect performance relative to a market cap-weighted scheme.
© 2015 London Stock Exchange Group companies.
London Stock Exchange Group companies includes FTSE International Limited (“FTSE”), Frank Russell Company (“Russell”), MTS Next Limited (“MTS”), and FTSE TMX Global Debt Capital Markets Inc (“FTSE TMX”). All rights reserved.
“FTSE®”, “Russell®”, “MTS®”, “FTSE TMX®” and “FTSE Russell” and other service marks and trademarks related to the FTSE or Russell indexes are trademarks of the London Stock Exchange Group companies and are used by FTSE, MTS, FTSE TMX and Russell under license.
All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by the London Stock Exchange Group companies nor its licensors for any errors or for any loss from use of this publication.
Neither the London Stock Exchange Group companies nor any of their licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Russell Indexes or the fitness or suitability of the FTSE Russell Indexes for any particular purpose to which they might be put.
The London Stock Exchange Group companies do not provide investment advice and nothing in this communication should be taken as constituting financial or investment advice. The London Stock Exchange Group companies make no representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the London Stock Exchange Group companies. Distribution of the London Stock Exchange Group companies’ index values and the use of their indexes to create financial products require a license with FTSE, FTSE TMX, MTS and/or Russell and/or its licensors.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.