Financial Dictionary - Underweight
In stock market terms, weighting refers to the weight of a specific asset with a group of selected assets, usually an index.
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In the case of the IBEX 35, 'weighting' refers to the weight of each of the companies that make up the index as a whole. This weight is determined by the market capitalisation of the listed companies.
As well as in stock market indices, weighting is used in securities portfolios. This means that each asset in a portfolio has a specific weight.
The term 'underweight' has two distinct meanings.
In one sense, 'underweighting' refers to investing in a specific security in a lower percentage than that security represesents in the benchmark index used to manage the portfolio. (See Benchmark index).
It's important to note that underweighting is not about selling because it's not a question of closing positions. Rather, it's a question of reducing the investment percentage of an asset in your portfolio.
An underweight in one or more securities in the portfolio occurs when the return on the financial asset is going to underperform in its sector or below its benchmark. Managers try to improve the performance of their portfolios by reducing the value of these assets and increasing the weight of other securities in their place.
'Underweight' can also refer to a financial asset being valued below its real value.
An asset is said to be 'underweight' when it has yielded a lower return than that of its sector over the past 12 months. This occurs in situations where
Underweighting a financial asset first requires carrying out a detailed analysis of the asset and its real value. If the conclusion reached determines that the real value is lower than its present value, you can underweight its value: in other words, bid less, sell it a lower price or even buy it a lower price.
This could represent a competitive advantage with respect to the market conditions, but the opposite could also occur if the asset doesn't perform according to forecasts. From a demand point of view, underweighting refers to an asset having a non-positive characteristic, which reduces both its marginal usefulness and demand.