Equal weighted index funds: Definition, formula, and key advantages

In the world of index investing, not all benchmarks weigh their holdings the same way. While many conventional indices rely on market capitalisation to size each component, equal weighted index funds give the same weightage to every constituent, regardless of its market size. This approach can provide distinctive risk and return outcomes compared to standard indices. But what is equal weighted index funds precisely, and how do they differ from typical market-cap strategies?

Below, we unpack the equal weighted index funds meaning, delve into their formula, and outline their advantages, disadvantages, and potential role in a broader investment portfolio—especially within mutual fund frameworks.

• Table of contents

• Understanding the concept of equal weight index funds
• Breaking it down further: Understanding equal weight index funds
• Calculating the allocation
• Contrasting market-cap weighting
• Advantages of equal-weighted index
• Shortcomings of equal weighted indices
• Performance track record
• Should you opt for equal weight?

Understanding the concept of equal weight index funds

An equal weighted index fund gives equal allocations to all the stocks (or whichever asset) it comprises. That means the same percentage is given to each component. For instance, if it’s an index of 100 stocks, each stock will have an allocation of 1%.

This way, smaller companies in that index can influence index movements in the same way as big companies.

This structure can increase potential returns if the smaller companies perform well but can also increase volatility.

Also Read: Mutual Fund And Portfolio Rebalancing

Breaking it down further: Understanding equal weight index funds

The process of understanding equal weight index funds starts with understanding how traditional market-cap indices work. Such indices (such as the Nifty 50, BSE Sensex and other common benchmark indices) are usually weighted by market capitalisation. This means companies with a larger market cap make up a bigger part of the index.

Conversely, an equal-weight approach levels the playing field, increasing exposure to smaller companies. But the index may have to be rebalanced often to maintain this equal weightage. If the value of one share rises sharply, it’s allocation must be brought back to an even weight, while underperforming shares would be brought back up to achieve equal weighting.

Calculating the allocation

The equal weighted index funds formula is fairly straightforward.

If an index has “n” components, each stock (or asset) is assigned a weight of 1/n.

Hence, if a basket comprises 50 stocks, each initially gets a 2% stake.

Over time, as some stocks rise or fall in value, their proportional weightage may change from 2%. The index must thus periodically rebalance to bring each back to 2%. This ensures smaller companies remain on an equal footing with larger ones in the index weighting.

Contrasting market-cap weighting

Market-cap-weighted vs equal-weight indices differ on:

• Concentration: A market-cap index may see 25–30% of its portfolio in the top 5–10 stocks (example for illustrative purposes only). An equal-weight index makes sure every stock has equal share.
• Volatility: Equal-weight indices are high in volatility because mid or small cap components can fluctuate more.
• Performance variation: Equal weighted indices may perform better than a market weighted index in a bull run, if the smaller companies on that index register higher growth, but amid volatility, a market-weighted index may have less downside risk because the more established companies in that index automatically take up more space.
• Rebalancing frequency: Equal-weight approaches must regularly rebalance to restore proportions. Market cap-weighted indices let stock weights drift according to market capitalisations.

Advantages of equal-weighted index

The advantages of equal weighted index funds include:

• Less dependence on giants: Avoiding overexposure to a few large companies reduces single-stock or single-sector risk.
• Rebalancing benefit: Because winners get trimmed and losers get added back in, the approach systematically buying low and selling high.
• Simple weighted democracy: Each stock’s performance matters equally, so the entire index can have a broad base for growth instead of relying on a handful of top companies.

Also Read: Optimising returns and mitigating risks

Shortcomings of equal weighted indices

Disadvantages of equal weight index funds may include:

• Higher trading and rebalancing costs: Maintaining equal weighting involves frequent rebalancing, which can increase costs.
• Enhanced volatility: Because it invests more in smaller or mid-tier stocks, the index can see sharper drops if broader small cap sentiment drops.
• Underperformance in mega-cap driven bull markets: If a major economic event is led by a few large technology or consumer firms, a typical equal-weight strategy might not work, as it won’t be able to suppress those winners.
• Liquidity concerns: Some smaller constituents might be lightly traded, raising liquidity challenges.

Performance track record

Historically*, certain equal-weight indices have outperformed their cap-weighted equivalents over years, particularly during periods when smaller or medium-sized stocks rallied. However, in market phases dominated by mega-cap growth stocks, equal-weight indices often lag. Observers see cyclical patterns: there are times when equal weight thrives (broad expansions) and times when it underperforms (narrow, large cap driven rallies). This cyclical tilt is key to anticipating short-term divergences.

*Past performance may or may not be sustained in the future.

Should you opt for equal weight?

Should you invest in equal weight index funds? The choice depends on risk appetite and market outlook:

• For those who like comprehensive rally capture, less exposure to concentration risk and systematic rebalancing, equal-weighted index could be suitable.
• If you want lower trading costs, simpler buy-and-hold investing, or greater exposure to bigger companies, a market-cap index may be more suitable and have potentially lower risk in comparison.

Additionally, some mutual funds incorporate an equal-weight methodology, giving you the professional oversight of a fund manager who invests along these lines. Evaluating your personal preference for diversification plus potential rebalancing gains can guide whether or not to use an equal-weight strategy.

Conclusion

Equal weighted index funds treat every component equally. This method can provide a more diversified portfolio and can lead to potential outperformance in certain market conditions, albeit with greater risk. By reviewing the equal weighted index funds formula, you can see how the weighting scheme diverges from standard indices. If you want a broader cross-section of the market, these funds may be suitable. In the end, whether you choose market-cap weighting vs equal weighting comes down to your risk appetite and outlook.

FAQs:

Is equal weight index better?

Not universally. It may outperform in certain conditions—like when smaller or mid-sized firms rally—but lag in mega-cap-led bull runs. Suitability depends on your risk appetite and perspective.

Which is better Nifty 50, or Nifty 50 Equal Weight?

No index is inherently better. The standard Nifty 50 index focuses heavily on top market-cap giants, whereas the equal weight variant invests in all 50 equally. The equal weight can capture broader potential growth in some conditions but might face higher volatility or rebalancing costs.

What is the difference between equal weight index fund and a market cap weighted one?

An equal-weight index spreads weight evenly across all constituents. A market-cap index proportionally weights stocks based on their market value, giving big names a bigger piece. This difference in weighting style affects returns and concentration risk.

How do you find the equally weighted index?

The stock exchange will usually explicitly call out an equally weighted indices in the index name (example BSE 200 Equal Weight Index or Nifty500 LargeMidSmall Equal-Cap Weighted).