Changes in the index constituents have never created such a hullabaloo. But when the index provider has decided to include Gautam Adani-owned flagship company Adani Enterprises in Nifty 50 in place of Shree Cement, all hell has broken loose, especially on Twitter.

According to Edelweiss Securities, the inclusion of Adani Enterprises in the Nifty 50 could result in a net inflow of around ₹1,700 crore, into the Adani Enterprises stock. On Friday, the stock hit an all-time high of ₹3,369.40 apiece.

Several tweets say that Adani group stocks will face similar fate as of Anil Ambani group; some question its fundamentals and high PE; others raise concern over its free-float, as it is heavily owned by promoters; and some are even worried that the inclusion will impact their EPFO (pension fund) returns, as EPFO invests in Nifty 50 exchange traded funds.

Should market participants turn so emotional?

Entry criteria

Exchanges (both BSE and NSE) revamp their index constituents on a semi-annual basis based on set criteria mainly market-capitalisation. The Nifty50 is computed using a free float-adjusted, market capitalisation weighted methodology, wherein the level of the index reflects the total market value of all the stocks in the index relative to a particular base period.

For a stock to qualify for possible inclusion into the Nifty50, it should have traded at an average impact cost of 0.50 per cent or less during the last six months for 90 per cent of the observations, for the basket size of ₹10 crore. That means, the stock must be highly liquid. Besides, companies must trade in F&O segment and have at least three months of trading history.

So, the entry of a stock purely depends upon the pre-determined quantitative model (quant) set up by the exchange. So any stock that meets those criteria will enter the index and Adani Enterprises is no different.

For those who raise concerns over free-float market capitalisation, weight of the index constituents is derived by applying Investible Weight Factors on full market capitalisation of respective companies in the index. This approach aims to limit the influence of a particular company in the index to the extent of its actual free float and reduces influence of large promoter/strategic holding (which generally is not available for trading) on the index. That means, Adani Enterprises will have a weightage of less than 0.4 per cent and cannot influence the index movement with large swings.

Bets on winning horses

As an index investor, should one worry if Adani Enterprises faces a similar fate that of ADAG stocks given its lofty valuation with respect to its fundamentals? Even if Adani Enterprises fails, index investors need not worry, as index will always bet on winning stocks.

For instance, Nifty and Sensex have returned a CAGR between 13 per cent and 16 per cent over 20-year period even with the inclusion and exclusion of wealth destroyers such as ADAG stocks, JP Associates, Unitech, etc. However, investors need to go through the short-term pain when these stocks slump. But as they get replaced with better companies’ stocks, the long-term index investors need not worry, as everything evens out over a period of time.

Nifty Next 50 index, where Adani Enterprises was top-heavy constituent until recently, has delivered superior CAGR of over 16 per cent as against Nifty50’s 13.5 per cent in the last 10 years.

EPFO is still miniscule

For pension funds such as EPFO, the inclusion is not going to change its performance drastically. According to 2019 annual report (the latest available), it has invested just 3 per cent of its ₹2.55-lakh crore assets under management. Besides, the biggest drag on EPFO performance currently is the CPSE ETF. 

So, investors who wish to make return over longer period through passive investments need not worry. For others, there are always more options which they can consider based on their overall investment style and return expectations.

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