Fisher Investments Reviews Why Portfolio Underweights and Overweights Matter

Transcript

Ken Fisher:

Thank you for listening to me. I say a lot of stuff and sometimes, without meaning to, I say jargon, and I realize that not everybody just thinks in jargon, of finance jargon. And so, a phrase that I'm sometimes asked about that I just throw around blithely is to "overweight" or "underweight" something. This could mean overweight in a country or underweighting a country overweighting an industry, or underweighting it, or even a single stock, if the stock is particularly big in the scale of the world. What does that mean, and where does it fit into portfolio management? And well, what should you do about it? So, let me offer you a couple of pieces of background. 

First, I think probably all of you know that the broad stock indexes, most of them, and all of the most credible ones, like the S&P 500 or the Morgan Stanley All-World, or the FTSE in Britain—or, or, or—are what's called cap-weighted. And what that means is, you take the total stock market value of each stock, you aggregate them, and the ones that are worth more have a higher weight in that index than the ones that have less total stock market value— price of the stock times the number of shares outstanding. Now, having said that, if you think about the S&P 500 or the world as a whole, you can think also, which is very common now, to think of that entirety as a potential path of investment. Like I'm going to buy a passive array of the S&P 500, which means I get exactly it, less a minor cost, and that's weighted more with the bigger stocks that are worth more in terms of price times total number of shares, less by the smaller stocks that have fewer shares and or lower price to make a lower total value. 

So, when we think of that—and we just use the S&P 500 as an example, but you could use any cap-weighted index, index is ranked by market cap. You say, is this industry—let's say, Tech or Industrials or Pharmaceuticals, Healthcare—what's its total money value as a percentage of the total index? And if you have more than that, you've overweighted it; if you have less than that, you've underweighted it. You can think that way, in terms of underweighting and overweighting, for industries, for countries—like, let's say you're thinking of the whole world, are you going to overweight or underweight America? Are you going to overweight or underweight Thailand? Your call, not mine. But the more you underweight or overweight, the more you're taking risk away from what the market returned, and therefore, the more your portfolio return is likely to be widely variant. 

So. if you take huge underweights and overweights, you could do much better than the index or much worse. If you have small underweights or overweights, you might do a little better, a little worse. The basis in theory for underweighting or overweighting is predicated on what do I actually know, or what do you actually know, that somehow, some way is good or bad about the industry, the country, the stocks, whatever, that other people don't know that hasn't already been priced into stocks, because the stock market's pretty efficient at pricing what we all already know about and talk about. 

So, if you actually think, I know something about Healthcare that's really important that other people don't talk about, they don't know about, and it's bad, well then, you'd have a natural inclination to underweight healthcare and that would be good. But if you just make the decision to underweight healthcare based off the same stuff everybody else talks about, knows about, and speculate about, that's a money-losing proposition, and you'll end up being hurt by that because it's already in the price of the stocks. 

So, basically, that's what underweighting and overweighting is, do you own more or less of it than it's weight inside the index that you measure it against? Why do you want to do this in the first place, Why do you want to think about index? Because overweighting and underweighting against an index like the S&P 500 or the MSCI World gives you a degree to which you can measure how much risk you're taking relative to the potential return you might receive. And if you want to try to hit big or go home, well then, you can underweight and overweight hugely, but you might go home. 

So, you need to make rational decisions about how much do I actually think I know that other people don't know, and I'm just going to tell ya, if you think you know a lot that other people don't know, you're probably pretty arrogant and wrong. For the most part, you have to pick your shots pretty carefully when you're underweight or overweight, but I'm not suggesting you don't pick your shots. So, I hope this has been useful for you. I hope it's given you clarity on what's otherwise a jargon phrase I throw around in these videos pretty commonly. 

And thank you for listening to me. And I hope again you listen to me on another video soon. Thank you. Hi, this is Ken Fisher. Subscribe to the Fisher Investment YouTube channel. If you like what you've seen. Click the bell to be notified as soon as we publish new videos.