Overweight is a term used by investment analysts for referring to those stocks which might outperform other stocks and the broader market or are worth buying. On the other side underweight is a contradicting term of overweight, wherein the investor analyst uses this term to refer to those stocks which have a poor future performance. Well, now you can assume the terms overweight and underweight as ‘buy’ and ‘sell’. This blog is to provide information about what does overweight mean in stocks.
What Does Overweight mean in stocks?
Before getting deeper into the concept of ‘stock overweight’, we must have a clear concept of stocks in general. The ownership certificate of any company is referred to as a ‘stock’ wherein a share is defined as a certificate of stock of a specific company. A person holding the share certificate of a company is referred to as a shareholder. A stock is also known as equity. These stocks are bought and sold in the stock exchange market with confined government regulations which are basically for protecting the investors from unfair practices. The online stock brokers help investors to easily buy these stocks over the net. These stocks are divided into two types, common and preferred.
An overweight investment acts as an asset or industry sector that contains a higher percentage of an index or portfolio. The investor tends to put a greater percentage of his portion into these overweight stocks because of their promising nature and greater returns in the future. Otherwise, investors also opt for overweight bonds and defensive stocks at the period when the stock prices are volatile.
The terms underweight and overweight are used to describe the nature of the stock, such as to avoid or buy a specific stock in the coming future, by the investment analysts. They also attach a recommendation to the stocks which they predict might underperform, average perform, or over-perform respectively.
An outsized investment in a specific asset type, asset, or sector index is known to be overweight. A stock or a sector is overweight by the portfolio managers based on the ability of the stock to perform well and boost overall returns. The surplus amount of an investment portfolio or an asset in a fund compared to the standard index that it tracks is referred to as overweight. Indexes are said to be weighted as they keep a track of the performance of a specific stock wherein each of these stocks constitutes a percentage of the index that differs with respect to its deemed impact on the whole.
The goal of the fund manager is to exceed or meet the standard that it is compared to, which can be achieved by underweighting and overweighting a few parts of the whole. So, in simple words, we can describe overweight as a stock that can potentially outperform other investments in the market or its industry. Hence it is called a ‘buy’ recommendation. On the other hand, when the fund manager suggests that a specific stock is underweight means they are less attractive than all the other investments in the market. Index managers tend to make a balanced portfolio for every investor and customize it according to their risk tolerance. A portfolio of 40 percent in bonds and sixty percentage in stocks will best suit an investor with a moderate inclination of risk. Only if this investor opts to invest fifteen more percent to the overall balance of stocks, then these stocks will be referred to as overweight.
Any portfolio, in general, can be overweight in a specific country or even a specific sector, such as energy. On a whole, a category or a particular part of it is overweight. For example, the stock market or sector can be referred to as a portfolio and the massive growth in the high yielding or dividend stock can be referred to as a category of the portfolio that is overweight. The comparison of the portfolio to the benchmark index or predefined standards is the entire concept behind ‘overweight’ stocks.
Pros and cons of overweighting
Actively managed portfolios and funds take up the overweight position in specific securities if it results in achieving greater returns. For example when the percentage of the portfolio increases from fifteen percent to twenty-five percent by the fund manager in order to grow the returns of the complete portfolio.
Apart from this, hedging is another reason behind why a portfolio is overweighting. Hedging is nothing but involves taking an opposite position or offsetting the related security. The derivative market is one of the most common methods of hedging.
The only risk of overweighting an investment is that the overall diversification of their portfolio can be reduced. The holding can be exclusively exposed to supplementary market risk by reducing the diversification of the portfolio. So collectively all the pros and cons can be listed below.
- May increase returns or portfolio gains.
- Hedges opposite to other overweight positions.
- The portfolio diversification is relatively reduced by overweighting.
- The portfolio is exposed to more risk as a whole.
Advantage of overweight in ratings and recommendations
When a stock is designated overnight by the investment and research analysts, it reflects a judgment that the stock will outperform its sector, industry, or the entire market.
The rating of overweight by fund analysts for a retail stock suggests that the share will provide an average return of the overall retail industry for the next eight to twelve months. The unconventional weighting recommendations are uniformly weighted or underweight. The security is assumed to perform with the index in a line along with the index wherein underweight implies that the security is assumed to lag.
There are countless opinions by people for stocks and shares whether they are worth investing in or not. A person can never sell or buy a stock based on the knowledge and mindset of the people residing there. The fund analysts often contradict or disagree with this. Therefore trying to find out the meaning of what the fund analyst truly means by the ratings is of no use.