Weighting for the Right One: Weighting Scheme Design for Systematic Equity Portfolios

Abstract

We examine eight weighting schemes frequently used in the construction of systematic equity strategies. Through the lens of both returns- and holdings-based analysis, we highlight the importance of having a close link between security weights and market prices. Ignoring prices, as in the cases of equal weighting, rank weighting, z-score weighting, inverse volatility weighting, and fundamental weighting, can result in extreme and uncontrolled deviations relative to the market, as well as excessive turnover and costs. Furthermore, our analysis of three price-based weighting schemes identifies the integrated core approach as the most effective at targeting multiple premiums, ensuring robust risk control, reducing turnover and costs, and accounting for different investor objectives and practical considerations.

Keywords: weighting scheme, factor investing, premium integration, multi-factor portfolios, portfolio design, asset allocation

JEL Classification: G11