Equal Weighting as an Indexing Strategy

Investment Need

When using an indexing investment strategy, a portfolio of securities is built to mirror a pre-determined stock market index. This may result in a higher concentration of risk when larger capitalization securities represent greater weight within the portfolio (as occurs with a market capitalization weighting strategy). Alternatively, an equal weighting strategy can reduce the portfolio?s concentration risk. Equal amounts are invested in each stock within the index, regardless of their relative market capitalization.

The equal weighting strategy identifies the pool of securities to be included in the portfolio. Since each security has an equal impact on performance, the impact of smaller securities compared to a traditional market capitalization index is accentuated. A 'floor' based on a certain level of market capitalization and/or liquidity is set. This ensures that stocks deemed too small and/or infrequently traded securities are excluded from the pool, mitigating the higher volatility often associated with such stocks.

Illustration

Using index data as of September 30, 2010, the top 10 names in the S&P/TSX Composite Index represent close to 34 percent of the market capitalization weight.

As well, sectors can have a very high security concentration risk, as shown in the following chart. Research In Motion (RIM), for example, represents almost 70 percent of the information technology sector.

Investment Opportunity

BMO Equal Weight ETFs provide investment opportunities that have lower security concentration and seek to eliminate unsystematic risk that can result from individual company risks.