Market capitalisation-weighted vs. equally weighted: Which is the better portfolio strategy?

When building an equity portfolio, sooner or later a fundamental question arises: how much weight should be given to each individual position in the portfolio? This question is by no means trivial, as the weighting influences not only the risk structure of a portfolio, but also its rebalancing logic, performance and robustness across different market phases.

Two strategies are particularly common:

1. Market cap weighted: The largest companies receive the largest share.
2. Equal weighting (1/N): Each security receives the same share of the portfolio, regardless of its size.

Many investors do not actively opt for one of these models. Instead, they invest in common index products such as ETFs, and thus automatically follow the market capitalisation-weighted approach. However, this “market logic” is only one of several possible strategies. Once you question it, you can decide how much influence individual large stocks have on your portfolio.

In this article, we compare both methods, covering how they work and their advantages and disadvantages, and explain why we use the 1/N approach in Everon’s multi-factor and income strategies.

What does market capitalisation weighting mean?

A market capitalisation-weighted portfolio (also called “cap-weighted”) weights each company according to its current size on the capital market. The market capitalisation is calculated as follows

Share price × number of outstanding shares = market capitalisation

The higher this value, the greater the proportion of the company in the portfolio.

Practical example:

An ETF on the MSCI World invests around 4 to 5% in Apple alone. Other giants such as Microsoft, Amazon and Nvidia also have high single-digit shares. At the same time, hundreds of smaller companies together often make up less than 10% of the portfolio.

The basic idea behind this weighting is:

“The market knows best how much a company is worth. So we are guided by this collective valuation.”

This form of allocation is simple, scalable and cost-efficient. It reflects the structure of the overall market without any active intervention.

Advantages:

• High liquidity: the largest positions are also the most traded securities.
• Low rebalancing effort: The portfolio automatically adjusts to market movements.
• Market coverage: The portfolio reflects the “market” according to its current structure.

Disadvantages:

• Concentration risk: A few mega-caps dominate the portfolio.
• Procyclical: Stocks that have risen sharply are overweighted; weak stocks are squeezed out.
• Index distortions: Valuation bubbles (e.g. Tech 2000 or AI 2024) are not corrected, but amplified.
• Value stocks are disadvantaged: Small, solid and cheaply valued companies can hardly carry any weight.

Reading tip: The development of the correlation between equities and bonds

What does equal weighting (1/N) mean?

The 1/N approach follows a simple principle: every position in the portfolio is given the same weighting - regardless of size, sector or market capitalisation. In concrete terms, this means that in a portfolio with 20 stocks, the weighting of each stock is exactly 5%.

How does this work in practice?

The weightings are constantly shifting due to price movements. An equally weighted portfolio must therefore be rebalanced regularly, for example monthly or at least quarterly. When rebalancing, outperforming stocks are trimmed back to their initial weighting (“profit-taking”) and underperforming stocks are increased accordingly. This creates a systematic counter-cyclical discipline.

Advantages:

• More even risk diversification: no one security can dominate the portfolio. This does not automatically make total risk lower, however.
• Counter-cyclical rebalancing effect: Winners are trimmed back, laggards are topped up.
• More weight for smaller stocks: they receive the same weight as large ones.

Challenges:

• Higher administrative costs: rebalancing is active and requires monitoring.
• Transaction costs: Regular rebalancing causes trading costs, especially for smaller, less liquid securities.
• Deliberate deviation from the index: An equally weighted portfolio deviates from well-known benchmarks such as the MSCI World and can lag behind them for several years.

An empirical look: How do the two approaches perform?

The evidence is mixed: over roughly 40 years to 2009, equally weighted portfolios of US stocks outperformed cap-weighted ones, but they lagged from 2016 to 2020.

• DeMiguel, Garlappi and Uppal (2009) compared the simple 1/N allocation with 14 other models, mainly mean-variance optimisation and its extensions. Out of sample, none of them delivered a consistently higher Sharpe ratio or certainty-equivalent return, or lower turnover, than 1/N.
• Plyakha, Uppal and Vilkov (2012) studied S&P 500 stocks over roughly 40 years. With monthly rebalancing, the equally weighted portfolio earned a higher return than the cap-weighted one at higher risk, even after adjusting for market, size, value and momentum factors.
• Taljaard and Maré (2021), by contrast, find that an equally weighted portfolio of S&P 500 stocks has significantly underperformed the cap-weighted one since at least 2016, and examine why.

Reading tip: Momentum as a return factor: the systematics behind relative strength.

Conclusion: Why we rely on equal weighting (1/N)

Market capitalisation weighting is justified - especially for passive index tracking and cost-effective market coverage. But it has structural weaknesses:

• Overweighting of hyped stocks,
• Neglect of valuation aspects,
• strong concentration on a few names.

The 1/N approach offers a deliberate alternative:

• It distributes risks more evenly,
• forces disciplined rebalancing,
• and gives smaller stocks more weight.

Our conclusion: The evidence is mixed. Neither approach leads in every market phase. For us, a more even spread of risk and regular rebalancing matter more than staying close to the index. That is why we weight the components of our multi-factor and income strategies equally. The price is that an equally weighted portfolio will at times lag behind a cap-weighted index, and we accept that.