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Page 6 of 7
DOES EQUAL WEIGHTING WORK INTERNATIONALLY?
It would be interesting to see if equal weighting an international portfolio results in similar differences to the risk/return characteristics of the portfolio as it does when equal weighting a U.S. portfolio. To provide some insight into this issue, a backtest was run for an equal weighted version of the S&P International 700, with the same methodology and rebalancing schedule as that of the S&P 500 EWI. The S&P International 700 is the international equivalent of the S&P 500. It is comprised of 700 of the largest, most liquid stocks from outside the United States. The S&P International 700 and the S&P 500 together comprise the S&P Global 1200.
To construct the international equal weighted index, we equal weight constituents of each of the following regional indices - S&P Europe 350, S&P TOPIX 150 for Japanese stocks, S&P/TSX 60 for Canadian stocks, S&P/ASX 50 for Australian stocks, S&P Asia 50 representing Asia ex-Japan stocks and S&P Latin America 40. These equal weighted regional indices are then GDP weighted to arrive at the composite international equal weighted index. We adopt this process to ensure that each region's weight is driven by its economic output, and not the count of stocks in its benchmark index.
Our results suggest equal weighting does seem to work in international markets as well. Similar to the S&P 500 EWI, the S&P International 700 EWI outperforms relative to its market weighted equivalent, has somewhat higher volatility, particularly in recent years, and over time has become increasingly correlated to its market weighted equivalent.
The S&P International 700 EWI has significantly outperformed the S&P International 700, by a greater margin than the S&P 500 EWI has outperformed the S&P 500. In fact, while the S&P 500 EWI has outperformed in certain market cycles and underperformed in others, the S&P International 700 EWI has consistently outperformed.
Exhibit 14 shows the style map for the S&P International 700 EWI relative to the a benchmark international index (S&P/Citigroup BMI Global Ex U.S.) using S&P/Citigroup international style indices. Here too, one notices a complex, time varying style map that suggests that international equal weighted strategy has a different set of style and size exposures compared to a benchmark index.
Exhibits 15 and 16 graph the historical volatility of the S&P International 700 EWI and the S&P International 700, and correlation between the two indices. The volatility of the S&P International 700 EWI, as measured by rolling three-year annualized standard deviations, was lower than that of the S&P International 700 from 1992 through 1995. However, starting after 1997 its volatility has been consistently higher than that of the S&P International 700, with the relative difference peaking in 1999 through 2000 and again in 2003 through 2004. Similar to the relative volatility of the S&P 500 EWI and the S&P 500, the volatility of the S&P International 700 EWI has recently exceeded that of the S&P International 700 by around 1.5% - 2.0%.
The correlation between the market cap and equal weighted versions of the international index has grown in recent times, consistent with the S&P 500 and S&P 500 EWI. Since 2003, it has been between .96 and .98. Unlike the U.S. indices, however, correlations have been stable in the 90% to 98% range over time.
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