In its Equal-Weight Benchmarking: Raising the Monkey Bars report S&P Dow Jones Indices said during times where the equal-weight index outperforms its cap-weighted counterpart, a portfolio of randomly chosen stocks will also outperform the capitalisation-weighted index.
The report said a study by Cass Business School, which was based on monthly US share data from 1968 to 2011, showed that “equity indices constructed randomly by ‘monkeys’ would have produced higher risk-adjusted returns than an equivalent market capitalisation-weighted index over the 40 years”.
“According to these results, in the period from 1969 to 2011, if you had picked stocks at random, there is a 99.9 per cent chance you would have beaten the market,” said the report.
Despite this, S&P Dow Jones Indices said active strategies are often sold on the basis of outperformance of the market-cap weighted index.
Given these findings, the report argued we should therefore being using equal weighting as a universal reference point for actively managed funds.
The research in the report also found that the average active large-cap US manager is likely to deliver a similar return to that of a hypothetical portfolio invested 80 per cent in the S&P 500 and 20 per cent in the S&P 500 Equal Weight Index.
S&P Dow Jones Indices said this is without the average fee of 1.3 per cent, however, and unspecified costs such as trading expenses estimated to be around 0.4 per cent.
The report said this demonstrates the “average manager tilts away from market cap, towards equal weighting, to a relatively small degree and while charging significant fees to boot”.
