What Is Underweight?
Underweight refers to one of two situations in regard to trading and finance. An underweight portfolio does not hold a sufficient amount of a particular security when compared to the weight of that security held in the underlying benchmark portfolio. Underweight can also refer to an analyst's opinion regarding the future performance of a security in scenarios where it is expected to underperform.
Key Takeaways
- Underweight refers to two different financial situations: (1) a portfolio that holds a smaller amount of a security when compared with a benchmark and (2) an analyst's opinion regarding the future performance of a security.
- An underweight portfolio is determined through basic math via percentage calculations while an underweight stock depends on the metrics the analyst chooses to use in their evaluation.
- An underweight portfolio is not necessarily a bad situation, it may mean the portfolio manager is not bullish on the asset.
Understanding Underweight
While an underweight portfolio can be identified through simple mathematics by determining what percentage of a portfolio is directed towards a particular asset, an underweight stock is identified on more flexible terms based on the variables chosen by the analyst who is making the determination.Underweight Portfolios
An underweight portfolio occurs when the percentage, or weight, of a particular security within the managed portfolio is lower than what is held in the benchmark portfolio. For example, if the benchmark portfolio held a particular security with a weight of 20% and the investor portfolio only held a 10% weight in that security, it would be deemed to be underweight in the security in question.A portfolio manager can make securities underweight if they believe those specific securities will underperform when compared to the other securities in the portfolio. For example, consider a security in the benchmark portfolio with a weight of 10%.
If the manager believes that the security will underperform over a certain time period, they can allocate the security a weight of less than 10% – say, to 8% – for that period. The 2% that is no longer directed towards that security can be allocated to other securities that have more positive outlooks in hopes of increasing the expected return for the overall portfolio.
Underweight Stocks
Analysts may refer to a security as underweight when the expected return is below the average return of the industry, the sector, or the market that has been chosen as a point of comparison. In this context, being underweight is similar to an expectation of poor performance and may be based on a few selected variables chosen by the analyst making the determination.
There is no set time frame or specific benchmark for an analyst to make this determination, which leads to variances based on analyst opinion and the exact variables chosen as a point of comparison. This can cause a stock to be considered underweight compared to one index, but not when compared to another, leading to two different recommendations.Example of Underweight
Consider Fund ABC which tracks the benchmark index, Index DEF. Index DEF has a weighting of Apple stock as 10% of its portfolio. Fund ABC determines that the future outlook for Apple stock is not strong given various metrics its research team used to analyze the company and the outlook of the economy. Fund ABC determines that its percentage of shares that are Apple shares will only be 1.5% of the portfolio. Compared to the benchmark, Fund ABC is underweight in Apple stock.