I Asked AI If Equal-Weighted Index-Trackers Are A Good Idea. The Response SHOCKED Me!

03/02/2025.  “If I am worried about market concentration, should I consider equal-weighted index trackers, rather than market cap weighted?”

Verbatim response (scroll down to read the Shocker, and learn why it's important):

If you are concerned about market concentration, there are several considerations to keep in mind when deciding between an equal-weighted index tracker and a market-cap weighted one:

1. Market Concentration Concerns: Market-cap weighted indices give significant weight to larger companies, which can lead to overly concentrated portfolios. An equal-weighted index distributes influence equally among all companies, reducing this concentration risk.
2. Diversification Benefits: Equal-weighted indices offer broader diversification by ensuring smaller and medium-sized companies have an equal impact, potentially reducing exposure to large, influential firms.
3. Volatility and Performance: While equal-weighted indices can provide smoother returns due to balanced contributions from all companies, they may be more volatile during market downturns or upturns caused by smaller companies' performance.
4. Transaction Costs: Maintaining an equal-weighted portfolio requires frequent rebalancing, which can result in higher transaction costs and management fees compared to market-cap weighted indices.
5. Market Efficiency: In efficient markets, prices reflect all available information, including company weightings. Equal-weighted indices may not fully capture this efficiency if smaller companies' performances are mispriced.
6. Historical Outperformance: Smaller companies (small caps) have historically outperformed larger ones due to innovation and risk-taking. Capturing this alpha potential can justify the use of an equal-weighted index.
7. Risk-Adjusted Returns: Consider whether the potential for higher returns from smaller companies offsets the added volatility, taking into account transaction costs and fees.
8. Correlation and Risk Management: Equal-weighted indices may offer diversification benefits due to varied correlations between small and large companies, enhancing risk management.
9. Long-Term Strategies: Evaluate if the expected long-term risk-adjusted returns of an equal-weighted index justify the trade-offs in volatility and costs.
10. Consultation with a Financial Advisor: Given individual financial situations and goals, consulting a professional can provide personalized advice on whether switching to an equal-weighted tracker aligns with broader investment strategies.

In conclusion, if your primary concern is market concentration and you believe smaller companies offer growth potential or diversification benefits, an equal-weighted index tracker may be advantageous despite its volatility. However, consider balancing these factors with the need for lower fees and a representative market view in a market-cap weighted index.

Now, some of these points are more relevant and salient than others.  But nevertheless, it’s a workmanlike summary of key considerations.  

But Here’s the SHOCKING FACT I Haven’t Told You Yet…

This AI model is DeepSeek R1 (Qwen 7B distillation), just 4.68 Gb downloaded onto my PC - a nothing-fancy two-year-old LG laptop.  GPU is an NVIDIA GeForce RTX 2050 – launch date December 2021.  Yet, I am running a 7 billion parameter model, with reasoning, totally isolated from the internet.  For free. 

(Admittedly, it took 4 minutes and 20 seconds to generate an answer to the question.)

Free High-Quality AI, Locally!  

The fact that this AI model – compact, reasoning and free – *can* deliver this output is the important thing.  Because it threatens some assumptions behind the meteoric rise of Nvidia and other related firms.  

A week ago, on Monday 27th January, Nvidia experienced a historic 17% drop in its stock price, erasing nearly $600 billion in market capitalisation, following the announcement of DeepSeek's cost-effective AI models. This marked the largest single-day loss in U.S. stock market history.

Chart: NVIDIA Weekly Share Price (click image for large view)

DeepSeek's competitive AI performance - without relying heavily on expensive hardware - could signal a shift in how AI is developed and deployed.  AI companies may not need to invest so much in high-end computation power.  

Similarly, cloud-based services such as Amazon (AWS), Microsoft and Google have been investing significantly in anticipation of increasing demand for AI.  Will DeepSeek and others mean that the demand can be serviced in other ways? 

I can imagine a near-future where Macs and PCs are shipping with high-quality reasoning AI pre-loaded. 

The point of this is dialogue is not to predict the future, but to underscore the risks of concentration in a small number of holdings. Nvidia represents about 6% of the S&P 500, and as of 31-December-2025, about 4.7% of the MSCI World Index.

Concentration is the Opposite of Diversification

Major indices such as S&P 500 (USA larger companies) and MSCI World (developed market equities) are ‘market capitalisation weighted’.  This means the allocation to each stock in the index is proportionate to the relative market cap of each company.  Larger firms make a larger part of the index.  

Most of the time, this seems logical.  Big companies have got big for a reason – and we like to ride the winners.  However, in the extreme, a small number of large companies can significantly outweigh all other constituents.  This is concentration.   

The S&P 500 index is more concentrated now that any time it’s history.  In December 2024, the top ten companies accounted for more than 37% of the index.  And with the S&P 500 itself representing about 51% of the entire global market capitalisation, that means that the top ten companies of the S&P 500 account for almost 20% of world market capitalisation.   

Equal-Weighted Equity Indices Offer Broader Diversification

Strategic concentration is absolutely fine, if such focus is our intention.  However, many investors choose broad equity index tracking funds because they want diversification.   This is why it’s worth considering equal-weighted index trackers when concentration is so extreme.

By equalising the weights of each holding in the index, we ensure that no single company, or a small group of companies, has too much influence.  Equal-weighted index trackers give a more diversified and balanced view of the market, and can help to reduce the downside risk of overly concentrated investments.

Equal-Weighted Index Historical Performance

If we have a quick glance at the chart below, we see that for the last fifteen years, the equal-weighted versions of the S&P 500 and MSCI World have underperformed their market-cap weighted brothers.   

This has become more pronounced since the COVID-19 crisis, an indication of the momentum-driven performance as large companies got larger.

Click image for large view.

  

However, let’s go back in time a bit more – to the peak of the DotCom bubble.  This was a time when stock index concentration was extreme (and notably, not as concentrated as now).

 

Ray Dalio on the ‘AI Bubble’

How similar is today’s market to that of the Dotcom era?  Respected high-profile investor Ray Dalio said last week in the Financial Times: 

“Where we are in the cycle right now is very similar to where we were between 1998 or 1999.  In other words, there’s a major new technology that certainly will change the world and be successful. But some people are confusing that with the investments being successful.” 

The tech-heavy Nasdaq 100 index doubled in 1999, only to fall about 80 per cent by October 2002. The index has doubled since the beginning of 2023 as stocks such as AI-focused chipmaker Nvidia have powered higher.

So, Yes.  

Equal-weighted index trackers are definitely worth consideration in the current environment.

No Artificial Intelligence was harmed during the writing of this article.