The authors note that most indices created in the wake of the S&P 500, that is, since 1957, are capitalisation weighted, as recommended by the capital asset pricing theory and the efficient market hypothesis. At the same time, there has been controversy about the degree of efficiency of the market. In other words, a broad capitalisation-weighted index may not be the most efficient investment. This consideration has led to the development of indices using alternative weighting methodologies. The simplest of these is the equal-weighted index. In addition, equal weighting randomises asset mispricing, as it is not based on any factor characterising the assets.

An equal-weighted version of the S&P 500 index (S&P 500 EWI) was introduced in 2003, and, according to the authors, it was the first index not weighted by market capitalisation widely used as an indexation medium. In this article, Dash and Loggie describe this index in detail, analyse its performance, and compare it to its capitalisation-weighted counterpart.

One notable advantage of the equal-weighted index is that it is less concentrated than its market-cap counterpart. In addition, this concentration is stable over time, as measured by the Herfindahl index, while the S&P 500 index exhibits higher concentration during periods in which large caps are in favour, as in 2000. In return, quarterly rebalancing means the S&P 500 EWI has higher turnover. The authors have also observed differences in the sector weightings of the two indices. Utilities and consumer discretionary sectors are consistently overweighted in the S&P 500 EWI, while heath care and communication services are underweighted, for the entire period beginning in 1998. For other sectors, the situation can differ, depending on the period. In addition, over time, the breakdown of the sectors is more homogeneous for the S&P 500 EWI than for the S&P 500, for which considerable variations are observed. For example, the information technology sector ranges from 10 to 15% during the period from 1998 to 2000 for the S&P 500 EWI; for the same period, but for the S&P 500, it ranges from 13 to 33%.

The authors also note some drawbacks of equal-weighted indices. One has to do with index turnover. Indeed, since its launch, the annual turnover of the S&P 500 EWI has been, on average, more than five times greater than that of the S&P 500. Of course, as the turnover of the S&P 500 is, on average, very low (about 4% per year), the turnover of the S&P 500 EWI remains in an acceptable range. Another concern, having to do with capacity constraints, is not after all a problem, what with the present amount of assets linked to the index.

Finally, the authors look into index performance. Since its 1990 launch, the S&P 500 EWI has, on average, outperformed the S&P 500 index by 1.5% a year. However, the difference in the performance of the two indices varies greatly from year to year. For example, the S&P 500 EWI significantly underperforms the S&P 500 index during the technology bubble in the late 1990s. The S&P 500 EWI, by contrast, significantly outperforms the S&P 500 index after the burst of the bubble, in the period from 2000 to 2002. This suggests that equal-weighted indices underperform market cap-weighted indices during bull markets but outperform them during bear markets. The volatility of the S&P 500 EWI was usually higher.

The authors have extended this research to international investment, using the S&P International 700 index and building a corresponding equal-weighted index. The results obtained in terms of performance are even stronger than those observed for the US indices, as the S&P International 700 EWI outperforms the S&P International 700 index not just in certain market cycles, but also consistently over the entire period. In view of these results, the authors conclude that the use of equal weighting to develop index products for international investment is to be expected.