Speaking of Fool’s Errands, from Kim Zussman
Here is an easy way to check whether equal weight or cap weight index out performs:
Cap-weighted index emphasizes return of large-cap stocks over small, and thus differs from equal-weighted index in which all stocks make equal contribution to index returns. It is well known that small cap stocks have out-performed large-caps in recent years, here shown by regressing weekly returns of Russell 2000 index vs. S&P 500 from 1/01-present:
Regression Analysis: RUT versus S&P 500
The regression equation is
RUT = 0.000274 + 0.920 SP500
Predictor Coef SE Coef T P
Constant 0.00027 0.00047 0.58 0.563
SP500 0.91963 0.02226 41.32 0.000
S = 0.0151692 R-Sq = 62.3% R-Sq(adj) = 62.3%
The small stock advantage becomes very small and insignificant. One conclusion is that small caps may out-perform large caps in some periods, but there does not seem to be a sustained advantage (even including recent out-performance).
Also interesting to consider that (widely used in academic finance) FF regressions have a term for a presumed durable small-stock effect, which in combination with increased popularity of various ETF and equal-weighted index products could help explain recent small-cap strength.