Catherine Yoshimoto
- Equal-Weight Indices: These indices help reduce the risk of outsized exposure to individual stocks within an equity universe.
- Effective Number of Stocks: This metric gauges the concentration level of an index, indicating how many stocks are driving its movements.
- Russell 1000 Insights: Recent data shows the index's highest concentration levels since inception, largely due to the dominance of top tech companies.
How can we assess concentration levels in a given index?
An index’s “effective” number of stocks tells us how many stocks are causing the index’s movements (not literally, of course, since all the stocks in the index contribute to its returns, but the effective number of stocks essentially gauges whether a smaller or larger group of stocks is “doing the work” in moving the index up or down).
So, the lower the “effective” number of stocks, the lower the number of stocks contributing to the index’s returns and the more the index is concentrated.
Our data for the capitalisation-weighted Russell 1000 index of US large-cap stocks since 1978, (Figure 1) suggests that the “effective” number of stocks has recently seen its lowest levels since the index’s inception, reflecting the high recent concentration of the index.
Figure 1: Russell 1000 “effective” number of stocks since 1978
Source: Russelll 1000 Index N - Equivalent since 1978. Please see the end for important legal disclosures.
Unless you’ve ignored financial media during the last year, you can’t have missed the stories about the “Magnificent Seven”—Apple, Tesla, Nvidia, Microsoft, Alphabet, Meta, and Amazon.
By early July 2024, the aggregate weight of the top ten constituents in the Russell 1000 index (seven of which are technology companies) had risen to 34%. To put this in context, just ten names make up over a third (by weight) of a 1000-stock index
The Russell 2000 is less concentrated
By contrast, concentration levels have been lower for the Russell 2000 index of US small-cap stocks (see Figure 2).
In fact, more than ten times the number of stocks were moving the Russell 2000 than the number moving the Russell 1000, even though the Russell 2000 has only double the stock count of the Russell 1000.
This relative lack of concentration in the Russell 2000 makes sense. If a company gains a very large weight in the Russell 2000 it is pretty certain to leave the index and graduate to the large-cap Russell 1000 at the next annual Russell reconstitution (see our recent guide for more on how the Russell US indexes are built). Whereas if a stock becomes very large (in relative terms) within the Russell 1000, it has nowhere else to go.
Figure 2: “Effective” stock scores for different Russell US indexes
Source: Concentration by Index October 31, 2024. Please see the end for important legal disclosures.
Equal-weighting the Russell 1000 and 2000
So, the Russell 2000 is less concentrated by nature than the Russell 1000, but can we go further?
Could we make the “effective” number of stocks in an index equal to the total number of stocks in the index, so that each stock is contributing equally to its return?
An equal-weighted index does exactly this. It equalises the weights of all the stocks in the index at each rebalancing point. So, in a 1000-stock index, each stock gets a weight of 0.1%, and in a 2000-stock index, each stock would get a weight of 0.05%.
We offer a number of equal-weight versions of core Russell indexes, including the Russell 1000 and 2000.
Equal-weighting an index embeds an automatic buy-low, sell-high policy: as stocks’ weights move out of line with each other between index reviews (reflecting the inevitable divergence in stock prices), we trim the weights of the outperforming stocks and add to the underperformers’ weights at each review.
This constant rebalancing means equal-weight indices incur higher internal turnover than their capitalisation-weighted counterparts. Although it should be pointed out that, as an investment policy, equal weighting makes less sense in a market with relatively high transaction costs.
Diversification is a hot topic
After the recent stellar performance of a few high-flying tech stocks, it’s unsurprising that diversification of stock-specific risk is once again a hot topic for investors.
Equal-weighting is a simple and easy-to-understand way of reducing stock indices’ exposure to individual stocks and sectors. The Russell Equal Weight Indexes add an extra layer of diversification by equal weighting the 11 ICB Industries before equal weighting the index constituents in each of the industries.
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