Market Cap versus Equal Weighting
Similar to many stock indexes, the S&P 500 is a market capitalization-weighted index. The market capitalization of each stock is determined by taking the share price and multiplying it by the number of shares outstanding. The companies with the largest market capitalizations, or the greatest values, will have the highest weights in the index. The weight of a company in the index is equal to the market cap of that company divided by the total market cap of all the companies in the index. As of the end of 2018, the top ten constituents of the S&P 500 index comprised 18.1% of the index.
An equal weighted index is just as it sounds. Every stock in the index has the same weight, regardless of how large or small the company is. Therefore, even the largest stock will have the same weight (0.2%) as the smallest company that is a constituent in the S&P 500.
Greater Diversification Potential
Equally weighting all stocks in a portfolio is a simple yet effective way to reduce the risk of over-concentration inherent in cap-weighted portfolios. Equal weight investing reduces the dominance that a few large stocks can have on overall performance. In addition, equal weighting provides more consistent exposure to sectors over time which contributes to potential out-performance.
Consider that over the last 10 years, the smallest 450+ stocks in the S&P 500 Equal Weight Index not only outperformed the same stocks in the cap-weighted S&P 500, they beat the entire S&P 500 Index's return by 17%.
Excess Return Potential
Since inception, the S&P 500 Equal Weight Index has outperformed the cap-weighted S&P 500. Excess return potential is derived from a combination of greater diversification and quarterly re-balancing.
Source: FactSet Research Systems, Inc., as of March 31, 2018. Past performance does not guarantee future results. An investment cannot be made directly into an index. Index returns do not represent fund returns.