What is equal weight index investing and why it's the flavour | Explainer

"In case of individual stocks, in an equal weight index, the top 10 stocks make up only a little over 20 percent of the portfolio. On the other hand, in case of a traditional index like the Nifty 50, stocks with a higher free float will have a higher weight in the index. For example: In the Nifty 50 index, as on January 24, 2023, Reliance Industries has the highest weight at 10.98 percent and BPCL has the lowest weight at 0.38 percent. Such uneven distribution could cause the index to outperform or underperform, depending on the performance of the stocks with the highest weightage," he said.

So, in case of an equal weight index, no stock can unduly influence the index movement as all stocks get almost the same representation, thus making for a fairly well-diversified portfolio.

As per Haria, an equal weight index tends to perform well during times of a broad-based market rally. For example, in the market up-move post the pandemic induced correction of March 2020, there was an extensive rally seen in Indian equities.

"Such moves help equal weight indices as all the stocks get to participate in the rally in almost equal measure. Similarly, in a falling market, they may cushion downsides better as weightage to individual stocks is restricted to just 2 percent i.e. in case of Nifty 50 Equal Weight index. Thus, through the equal weight index the movements on the upside and the downside are tempered," Haria said.

Alternately, during times like the year 2019, when just a few benchmark heavyweights led the index rally, an equal weight index would be under pressure.

This reflected in the return profile where the Nifty 50 TRI delivered 13.5 percent return while the Nifty50 Equal Weight TRI was 4.3 percent, Haria added.

When there is a rally in most of the index constituents/sectors, it is considered to be a broad-based rally. The recent example of such a rally was post the pandemic wherein all the sectors participated in the up-move.

On the other hand, in 2019, while markets registered new highs, the entire up-move was on account of just a few index heavyweights. This is an example of a concentrated rally.