Overweight

What Is Overweight?

An overweight investment is an asset or industry sector that comprises a higher-than-normal percentage of a portfolio or an index. An investor might choose to devote a greater portion of the portfolio to a sector that seems particularly promising, or an investor might go overweight on defensive stocks and bonds at a time when prices are volatile.

Overweight and its opposite, underweight, are also used by analysts and commentators in recommendations to buy or avoid particular investments or sectors. For example, if federal defense spending is about to be increased or decreased, an analyst may recommend that an investor go overweight or underweight on defense-related companies.

In addition, many analysts attach an overweight recommendation to a stock that they believe will outperform its sector in the coming months. The alternative ratings are equal weight (for average performers) or underweight (for below-average performers).

Understanding Overweight

Strictly speaking, overweight refers to an excess amount of an asset in a fund or investment portfolio compared to the benchmark index that it tracks.

Indexes are weighted. That is, they track the performance of a selection of stocks, each of which represents a percentage of the index that varies according to its perceived impact on the whole.

Mutual funds also are weighted, and some percentage of the fund may be devoted to cash or to interest-bearing bonds in order to reduce overall risk. This is why the performances even of index mutual funds may vary fractionally from each other and from the index itself.

The fund manager's goal is to meet or exceed the index that it is compared to. That may be achieved by overweighting or underweighting some parts of the whole.

Beating the Trend

Otherwise, there is no firm definition of overweight. It is simply a variation from the norm, whatever that might be. For example, the manager of a global technology mutual fund who foresees a downturn ahead might shift some assets, going overweight on some of the stablest blue-chip companies out there. An investor with a diversified portfolio who foresees a downturn might go overweight on interest-bearing bonds and dividend-paying stocks.

Overweight can also refer — in a looser sense — to an analyst's opinion that a stock will outperform others in its sector or the market. In this sense, it is a buy recommendation. When an analyst suggests underweighting an asset, they are saying it looks less attractive for now than other investment options.

Bucking the Norm

Portfolio managers seek to create a balanced portfolio for each investor and personalize it for that individual's risk tolerance. A younger investor with a moderate appetite for risk, for example, might be best served by a portfolio that is 60% in stocks and 40% in bonds. If the same investor then opts to move 15% more of the balance into stocks, the portfolio would be classified as overweight stocks.

A portfolio can be overweight in a sector, such as energy, or in a specific country. It may be overweight in a category, such as aggressive growth stocks or high-dividend-yielding stocks. In this context, the term overweight usually implies that the portfolio is being compared to a predefined standard or a benchmark index.

Overweighting Pros and Cons

Actively managed funds or portfolios will take an overweight position in particular securities if doing so helps them to achieve greater returns. For example, the fund manager may raise a security's weight from its normal 15% of the portfolio to 25%, in an attempt to increase the returns of the overall portfolio.

Another reason for overweighting a portfolio holding is to hedge or reduce the risk from another overweight position. Hedging involves taking an offsetting or opposite position to the related security. The most common method of hedging is through the derivative market.

For example, if you hold shares of a company currently selling at $20 per share, you may purchase a one-year expiration put option for that stock at $10. A year later, if the stock is selling at more than $10 you let the put expire, losing only the price of the purchase. Should the stock be selling for under $10, you may exercise the put and receive $10 for your shares.

The danger of overweighting one investment is that it can reduce the overall diversification of their portfolio. A reduction in diversification can expose the holding to additional market risk.

Use of Overweight in Ratings and Recommendations

When research or investment analysts designate a stock overweight, it reflects an opinion that the security will outperform its industry, its sector, or the entire market.

An analyst's rating of overweight for a retail stock would suggest that the stock will perform above the average return of the retail industry overall over the next eight to 12 months.

The alternative weighting recommendations are equal weight or underweight. Equal weight implies that the security is expected to perform in line with the index, while underweight implies that the security is expected to lag the index in question.