Nowadays many traders fret over the inclusion of a stock in an index — a normal course of action in the stock market — kicking up heated debates. Index funds have gained popularity in recent years as investors prefer passive investment options.

The total number of passive funds (ETFs and Index Funds) tracking Nifty Indices recently crossed the new milestone of 200, managing assets over ₹4-lakh crore.

As billions of rupees ride on index and exchange traded funds, it is the right time for market participants to know about the key factor of index funds — weightage, and two categories of index funds — market-capitalisation based and equal-weight.

Weightage of Adani stocks

For instance, the latest entrants to market-capitalisation based Nifty50 — Adani Enterprises and Adani Ports & SEZ — carry less than 1.5 per cent weightage together, while Reliance Industries at 10.6 per cent tops the list, followed by HDFC Bank (9.17 per cent) and ICICI Bank (7.8 per cent).

That means the influence of Adani stocks will be negligible whereas the top three or four stocks with high weightages can influence the index direction, as the allocation of funds is skewed towards large-cap stocks.

On the other hand, in equal-weight index, as the name suggests, each stock carries same weight i.e. two per cent each in Nifty50 index and one per cent each in Nifty100. 

Yet to gain popularity

World over, investors prefer market-capitalised index funds, as equal-weight is yet to gain prominence. 

The main advantage of equal-weight fund is that it removes the market-cap bias. This means even the smallest weighted stocks command equal power. In a sense, equal-weighted indexes are more diversified than market capitalisation-weighted, and, therefore, may carry less risk. Equal-weighted funds are believed to be a superior investing strategy, as they focus on value investing. However, at times they turn more vulnerable due to volatility caused by a sudden event in a particular stock or sector — similar to Adani group stocks rout.

Also read: Investment in Adani stocks boosts market confidence

For instance, equal weight Nifty50 index slumped nearly 3.2 per cent since January 31 against 1.92 per cent decline of Nifty50 index.

Performance comparison

So, should one avoid equal-weight index funds? While empirical study in global context gives a mixed view, in domestic market it appears equal-weight index beats market-cap hands down in the long run for various durations.

For instance, looking at the five-year return of Nifty50 index from January 1, 2000 to December 31, 2005, the Nifty50 fell 20.65 per cent against 19.2 per cent fall of equal-weight index. For those who had held it for 10 years from 2000, the returns were mindboggling. As against Nifty50’s return of 78 per cent, equal weight produced a return of 161 per cent. For those who stayed invested in the ETFs of market-cap based Nifty 50 and Nifty50 equal weight till now, the comparable return is 987 per cent and 1,373 per cent, respectively.

Similarly, Nifty100 equal weight produced a whopping return of 1,832 per cent against Nifty 100 index’s 1,613 per cent, since 2003, the base day of the index.

This suggests, at least in the Indian context, that equal-weight scores over market-cap based in the long run, despite the entry and exit of volatile stocks. This holds true for market-cap based index, too.

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