🧠 Equal Weight against AI bubble?

The 10 largest companies now represent over 35% of the S&P 500 and nearly 26% of the MSCI World. That's a record level of concentration.

And it’s got a lot of investors concerned.

To counter this concentration, some fund managers are suggesting the following solution: give each company the same weight.

Funds where each company carries the same weight in the index, whether it's worth €3 trillion or €3 billion.

This is the principle behind "Equal Weight" funds.

Less concentration on the giants, so that an investment portfolio won't collapse dramatically if a crisis hits.

• Does this approach perform better over time?

• What are the benefits... and what’s the catch?

• And what’s the price tag for keeping things balanced?

Let's dive into this today.

Market-Cap Weighted: the natural index

This is the most common approach.
The higher a company's market valuation, the more weight it carries in the index.

You already know the advantages if you invest in a popular index ETF: market performance is accurately reflected, fees are low (limited rebalancing needed per year), and liquidity is great.

Major drawback: concentration.

When the giants rally, they lift the whole index with them. When they crash, they drag it down too.

The Market-Cap index reflects its era: right now, it's tech; yesterday it was telecoms.

Equally Weighted: levelling the playing field

The major equal weight indices as we know them today emerged in the early 2000s, offering a less concentrated alternative to traditional indices. The goal is both to limit the weight of giants and to give smaller companies more say in the index, since each company carries the same weight.

More "democratic", but also:

• more volatile;

• higher fees (frequent rebalancing required);

• and uneven performance... depending on the economic cycle.

If smaller companies outperform the broader market, your equal weight ETF can do better than a market-cap ETF.

But if large companies or a specific sector experiences major growth and drives the market upward, then you risk underperforming the market.

A 20-year study by S&P Global shows that the equal weight S&P 500 index beat the traditional market-cap index by an average of 1.2% annually.

Sounds pretty good, doesn’t it?
If we left it at that, it’d seem like a no-brainer.

But we're forgetting that an index is just a theoretical average with no costs, while an actual fund has to pay management and rebalancing fees before you see any returns.

And even though the study shows that equal weight remains very well positioned compared to active funds over 20 years (even when simulating fees ranging from 0.5% to 2% per year), this does not mean that an equal weight ETF will automatically perform better than a simple, very inexpensive market cap ETF.

With equal weight funds, winners get trimmed back when exceeds the target weight, while underperforming ones get topped up when they shrink, to keep all holdings equal.

These back-and-forth transactions generate significant trading costs for fund managers, which are passed on to us investors (the obvious cost is the TER, and the hidden one* is tracking difference).

*No trickery involved; fund managers simply don't know in advance how many rebalances will be needed during the year.

When tech giants dominate markets, as they do currently, these repeated sales limit gains. But on the flip side, if a bubble bursts, the fund is less exposed to the fall of these giants.

When looking at the very long term:

In this analysis published in January 2025, Vanguard reminds us that over the very long term, market-cap weighting often remains the simplest, most economical, and most suitable solution for a passive approach.

That's because it naturally follows the market, costs less to manage, and offers good liquidity.

The equal weight approach shifts the risk: we move away from heavyweights, but shift exposure towards small and medium-sized companies, which have fewer financial resources to weather crises, and often depend on just one product or one market.

So to sum up, choosing an equal weight fund is similar to "active" management strategies. You believe regular interventions are necessary to reduce concentration on the titans, but you expose yourself to other risks mentioned above.

The risk of an "AI bubble" justifies carefully assessing your concentration risks, but are equal weight funds THE optimal solution for everyone to counter this risk?
No.

There are other ways to tackle this, such as: adding exposures to small and mid-cap companies, investing across different regions, or shifting some money into other assets (bonds, real estate, commodities, etc.).

It's up to you to decide whether the equal weight approach aligns with your risk tolerance and goals.

Take care,
Nessrine

Sources that informed this issue:

• Vanguard – What to consider when choosing between index weighting approaches

• S&P Global – More Equal Than Others: 20 Years of the S&P 500 Equal Weight Index

• Morningstar – Where Invesco S&P500 Equal Weight Falls Short

• VanEck – A better way to equal weight?