Will equal weighted Nifty continue to deliver?

In the sharp market rebound since last year, the frontline Nifty50 index has emerged only second best. It has been comfortably upstaged by its modified avatar—the Nifty50 Equal Weight index. The latter has gained 110% since the March 2020 lows, as compared to the 95% gain in the Nifty index. Should investors persist with the traditional index or ride its offshoot?The equal weight index differs from the mainstream index in its composition. The bellwether index weighs each stock according to its free-float based market capitalisation. So companies with higher market cap as a proportion of total index market cap enjoy higher weight in the index. But the equal weight index simply gives each stock equal weight in the basket. Vidya Bala, Head – Research, Primeinvestor, points out, “The equal weight index will artificially prop up or cap weights of stocks relative to the main index.” This attribute is what has put the modified index ahead of its counterpart in recent months. This is visible in equal weight versions of both Nifty50 and Nifty100 indices.For the past few years and even during initial days of last year’s market rebound, only select few stocks were contributing to the market gains. The index heavyweights set the pace even as others fetched insipid return. This allowed the traditional market-cap biased index to post smart gains as the equal weighted version fell behind. However, this changed towards the end of last year when more stocks started participating in the market uptick. As the rally started getting broad-based, the equal weighted index benefited. Sharp gains in stocks finding lower weight in the mainstream index—mainly cyclicals and value stocks—outperformed for the latter. “After years of underperformance, reversion to mean has started happening in favour of equal weighted strategy,” says Kalpen Parekh, CEO, DSP Mutual Fund.But this outperformance merely covers the last few months. Does the equal weighted index hold its ground over longer time frames? The Nifty50 Equal Weight Index has outperformed the Nifty 50 Index in 13 out of the past 22 calendar years, starting 1999. Based on daily rolling returns, NSE data shows that for a 7-year investment horizon, the Nifty50 Equal Weight Index has outperformed the Nifty 50 Index 67.7% of the time. The frequency of outperformance rises to 71.6% when we consider longer time horizon of 10 years. Considering the stellar outperformance, should investors turn to equal weighted index for good?By nature of its construct, equal weighted index offers better diversification than its market cap weighted sibling. Financial services companies take up nearly 38% of the Nifty50 index. By contrast, its equal weighted avatar only has 22% exposure to this basket. The top 10 stocks comprise more than 60% of Nifty50 index whereas they eat around 20% of the equal weight version.The traditional index can often get caught out because of its market cap bias. As a stock or sector performs well, they take up larger space in the index. This potentially exposes the index to risks as rotation of market preferences away from the market darlings can have outsized impact on the index. The equal weighted index, on the other hand, is less dependent on the fortunes of a few.Equal weight strategies have outpaced traditional indices......But returns lag behind market-cap based indices over three years 82115757Experts insist equal weighted strategy can be a good long term addition to the portfolio. However, be prepared to ride out intermittent phases when it lags the main index. This is because the equal weight strategy is likely to do well in periods when broader set of stocks do well. But if the market becomes polarised again, it will lose out to its counterpart. Parekh insists it can be a core strategy for long-term investors comfortable with bouts of underperformance. “In an economy where more sectors beyond the top few can be expected to contribute to profits, equal weighting makes sense. Over a full cycle, it tends to do better than the traditional index. Equal weight can be expected to work better during regime changes when leaders of the next decade or two are likely to come from different sectors.”Others can consider equal weight strategy a tactical play. Given that it keeps rotating in and out of favour, investors can time the entry at a point where the strategy has been underperforming the mainstream index for a while. Parekh says, “Reversion to mean in favour of equal weighting typically starts when it has underperformed the main index by around 15%.”However, not everyone is convinced of its merits. Rohit Shah, CEO, Getting You Rich, remarks, “By investing in a tweaked version of the traditional market-cap based index, you are going against the collective wisdom of the marketplace.” Bala also feels that if you are anyway investing in the market (index), it is best to align with it. “With equal weighting, you end up capping return from stocks that the market is favouring.” With no way of knowing what strategy will work when, it is best if such strategies are used as complementary bets. Investors considering this as an alternative strategy can pick from DSP Equal Nifty 50 Fund, Sundaram Smart Nifty 100 Equal Weight Fund or Principal Nifty 100 Equal Weight Fund. The last two schemes are likely to be merged into a single fund in the coming days.

from Economic Times https://ift.tt/3n0GMdN