Equal-weighted exchange-traded equity funds have attracted notable amounts of investor money in the past 12 months as investors move away from ETFs that track standard market indices which typically assign large weights to equities with the largest market worth at the expense of smaller, but still worthwhile, stocks. Daniel Dornel explains.
The shift reflects investor concerns that market capitalisation weighted indices have come to be comprised of fewer and fewer stocks as a handful of corporate giants attain billion-dollar market valuations.
These mega-cap stocks have risen to dominate major market indices such as the US S&P500 or the MSCI World index on the back of significant share price gains.
High levels of concentration in an index obviously entail a considerable risk, for example, in the case of a price correction for just one or two of these mega caps, also known as the Magificent-7.
Investors have come to realise that an equal-weighted investment approach can offer portfolio diversification from the Magnificent 7 and as well as US equities generally.
Below we take a closer look at the MSCI World index and ask whether it can actually be seen as a ‘world index’.
MSCI World – How concentrated is it?
This diversified developed market index has over 1,350 constituents from 23 countries. These figures hide a more complicated story: most of its recent performance has come from a few stocks. For example, in 2024, the Magnificent-7 contributed close to 50% to index performance with US chipmaker Nvidia accounting for 19% of that.
Looking more closely at the MSCI World’s composition, we find the five largest companies (out of over 1,350) currently account for close to 20% of index capitalisation. Concentration has kept increasing over the last 10 years, with the top-five companies’ weight going from 6% to a record 20% at the end of 2024.
This has ramifications for portfolios. There is significant exposure to technology stocks given the nature of the Magnificent-7. In the last 10 years, the weight of the information technology sector in the MSCI World rose from some 10% to over 25%.
Even more impressively, out of the 23 countries in MSCI World, the US represents around 75% of the universe. We note the weight of the US has also been increasing significantly over the last decade.
Looking to diversify from US mega caps
Early 2025 trends showed a notable bias towards US and global equities before US equities saw outflows in February, March and April. Flows into global equity products continued at a greater clip and investors poured into European equities, making the first quarter the largest for European equity flows with €24.9 billion.
These numbers suggests to us that investors are diversifying away from US mega-cap stocks and more generally are reducing their US equity exposure.
Looking at the longer-term trend, we have seen significant investor interest in strategies applying an equal weighting to constituents.
Significantly reduced exposure to US
Such a strategies can take into account environmental, social and governance (ESG) considerations using, for example, the MSCI World Equal Weighted Ex Business Involvement Screens Select index.
This excludes companies involved in fossil fuel extraction, thermal coal power, controversial weapons, and tobacco production. It also excludes companies with the lowest ESG score.
Applying an equal-weight approach on a MSCI World universe curbs the concentration of the portfolio. In the case of the MSCI World Equal Weighted Ex Business Involvement Screens Select, the aggregated weight of the top-10 stocks falls from 23% to only 1.4%.
From a sector point of view, the equal-weight approach limits the exposure to the IT sector, while overweighting sectors such as industrials and materials.
Equally weighting constituents also allows for a more balanced portfolio with a reduced weight for the US (to under 40% of the universe for the MSCI World Equal Weighted Ex Business Involvement Screens Select).
Conclusion
Equal-weight equity ETF strategies have proven appealing this year: since the beginning of 2025, the MSCI World Equal Weighted Ex Business Involvement Screens Select index has outperformed the standard MSCI World by over 6.5%.
This can be explained by its reduced exposure to the US and, more importantly, to the US IT sector whose market performance has suffered since the start of the year.
We believe this underscores the potential benefits of an equal-weighted approach to a global investment universe: it can create a more balanced portfolio with greater diversification while maintaining some exposure to a large market such as the US.
