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Traditional indices weight companies based on their size. The resulting concentration risk and “the big get bigger” theory is a criticism levelled by many active managers who are critical of index investing.
Leaving aside the flaw in that argument (company's valuations determine their size in an index, not the other way round), it is important to remember that using traditional indices is a choice, not an obligation.
One alternative weighting scheme is to weight each share within an index equally, regardless of the size of the company.
Sounds simple? In a way, it is. But what’s interesting is understanding what an equal weight approach means from a diversification perspective, risk perspective and underlying factor-bias.
The curious power of equal weight is why some equal weight strategies have seen significant inflows over the last 6-12 months.
Register for our CPD event exploring this topic in more detail on Wed 23 June at 10.30am