What is an Equal Weight Index?
An equal-weight index is a stock market index that gives the same weightage to all stocks that are included in it. In other words, each stock in the index is given the same importance while determining the total value of the index.
The index comprises companies with different market capitalizations. Unlike the market cap-weighted index, whether each company is large or small, it will be given equal weightage in the index.
An equal weight index fund is similar to an ETF or index fund. The fund primarily invests in the stocks of the underlying benchmark index. Also, these funds invest in stocks of publicly traded companies and distribute funds equally among all stocks of the underlying benchmark index. Therefore, the performance of each stock affects the index fund’s performance.
The formula to determine the value of this index is –
Value of equal weight index = (Price of stock A * weight assigned) + (Price of stock B * weight assigned) + (Price of stock C * weight assigned) +….so on.
Features of Equal Weight Index
The following are the features –
- Equal Weight of Constituents: This is the most important feature, as all the stocks start with an equal weightage irrespective of the market capitalization, firm size, or share price.
- Rebalancing: This index is rebalanced quarterly or half yearly, and the weightage of every stock is reset and brought back to the same level, which may have drifted due to price movements.
- Costs: Due to the frequent buying and selling of stocks to adjust the weightage, the trading cost of funds tends to be high.
- Diversification: This provides more diversification than the market weighted index as it avoids concentration only on a few big stocks.
How Does NIFTY 50 Equal Weight Index Work?
Each stock of this index will have the same weightage. Similarly, the Nifty 50 equal weight index is an alternative weighting index strategy that includes the same 50 stocks as the Nifty 50 index but is weighted equally. In other words, the Nifty 50 equal index aims to measure the performance of stocks forming part of the parent index, i.e. Nifty 50 index.
For instance, the Nifty 50 equal weight index will start with a 2% weightage for all stocks. Over a period of time, the stock price may move up or down. Depending on the performance of each share, the weights will change. Therefore, the rebalancing of weights is done quarterly, where all the stocks are rebalanced to equal weight gain.
During the rebalancing period, stocks whose prices have increased and accordingly the weightage in the index have also increased. Thus, the weightage is revised down to 2%. On the other hand, the stocks whose prices have decreased and weightage in the index has also decreased, their weightage is revised up to 2%.
For instance, if stock A has done well in the current quarter and the weight has increased to 2.93%. The weightage is reset to 2% during the rebalancing by selling some stocks.
Equal Weight Index Vs Market Cap Weighted Index: Key Differences
The following are the key differences between equal weight index and the market cap-weighted index.
|Parameters||Equal Weight Index||Market Cap Weighted Index|
|Weight in Index||Equal weight to all stocks||Based on their market capitalization|
|Diversification||Equal||More weightage towards large cap stocks|
|Performance||Not much impacted||More impacted by large cap stocks|
|Rebalancing||Periodically every quarter or semi-annually||Not required|
|Factor exposure||Valuation based||Momentum based|
Under the market cap-weighted strategy, there is more weightage towards the larger stocks. On the other hand, the equal weight strategy diversifies across a broad range of securities and sectors within the index.
In certain market conditions, the concentration of stocks in one sector which is performing well benefits the market cap-weighted strategy. It benefits when the markets are going up but is also negatively impacted when markets fall. Thus, the concentration of risk is more.
In contrast, with the equal weight strategy, which has a smaller weight to every stock, the performance of the index is not impacted as much as the market cap weighted strategy.
The broader market index is less risky from a security or sector concentration view. It means the overall risk of security exposure reduces. In contrast, there is more volatility because smaller stocks have more weightage than the benchmark index.
The market cap-weighted index proportional weight remains the same irrespective of how the market performs. On the other hand, the equal weight index is rebalanced periodically, either quarterly or half-yearly, to maintain the same weight for all stocks at all times.
Rebalancing the equal weight index also makes the valuation change in the portfolio. To maintain the desired weight, the strategy sells shares that have appreciated relative to their target weight and uses the proceeds to buy shares that have declined. Therefore, this strategy shifts the focus to stocks with smaller capitalization and lower valuations which had outperformed historically.
While the market cap strategy continues to maintain the same proportion across the stocks irrespective of their valuation.
The market cap-weighted index is more driven by the momentum of larger stocks. On the other hand, an equal weight strategy takes more value exposure in the market as it shifts its focus away from larger stocks.
Frequently Asked Questions
The Nifty 50 equal weight index fund is taxed similarly to the equity funds. It depends on the holding period. If the holding period is less than one year, then short-term capital gains are applicable, which are taxable at a flat 15%. If the holding period is more than one year, then long-term capital gains tax is applicable where capital gains up to INR 1 lakh are exempted. Above INR 1 lakh is taxable at 10% without indexation.
The equal weight index offers dual benefits to investors with reduced concentration risk and more exposure towards small-cap stocks. However, they also have a higher turnover ratio and may also underperform at times when certain stocks are highly volatile. Selecting either of the indexes depends on the investor’s investment strategy.
Investors looking for diversification and stability through rough market conditions consider investing in an equal weight index fund that tracks the index Nifty 50 and Nifty 100. Also, those who prefer a passive investing strategy without complete stock concentration can invest in this fund.