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Key Ideas
- Why does an equal-weighted portfolio outperform a capitalization-weighted portfolio over time?
- Most studies conclude this is because the equal-weighted portfolio has a larger allocation to small-cap stocks which are expected to outperform large caps.
- Our paper challenges that conclusion and shows that it is the need to rebalance the equal-weighted portfolio that explains the majority of the outperformance.
- We apply a new form of performance attribution which quantifies this rebalancing premium, and has potential application to other popular risk premia.
A well-known, but misinterpreted, effect
There has been no shortage of studies over the years concluding that portfolios of smaller-capitalization companies are expected to provide a return premium over their larger-capitalization counterparts over time.
