Equal-weighted strategy: Why it outperforms value-weighted strategies? Theory and evidence

Abstract

Recent academic papers and practitioner publications suggest that equal-weighted portfolios (or 1/N portfolios) appear to outperform various other portfolio strategies. In addition, as the equal-weighted portfolio does not rely on expected average returns, it is therefore assumed to be more robust compared to other price-weighted or value-weighted strategies. In this paper, we provide a theoretical framework to the equal-weighed versus value-weighted equity portfolio model, and demonstrate using simulation as well as real-world data from 1926 to 2014 that an equal-weighted strategy indeed outperforms value-weighted strategies. Moreover, we demonstrate that a significant portion of the excess return is attributable to portfolio rebalancing. Finally, we show that because of equal-weighting, the excess returns are higher than the higher costs incurred due to higher portfolio turnover. Therefore, even after accounting for higher portfolio turnover costs, equal-weighting makes economic sense.