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.
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.
An underweight portfolio occurs when the percentage, or weight, of a particular security within the managed portfolio is lower than that 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 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.
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 Being Underweight
Investors can use the concept of being underweight on a grand scale to make inferences about the market and individual stocks. For instance, according to a research note by UBS in May 2017, hedge funds held the least amount of Apple compared to its weighting in indexes at the time, making them historically underweight. The analysts interpreted the underweighting to mean that the stock would continue to advance as fund managers began buying it to catch up on its rallying performance.