Is RIL now the barometer of stock market?

The phrase, ‘stock markets are barometers of the economy,’ has never been applicable to the Indian stock market.

This disconnect has only grown more stark during the pandemic. While the economy is set to contract over 10 per cent this fiscal, the Sensex and the Nifty 50 have rebounded almost 50 per cent from the March 2020 lows.

Other global markets are also rallying similarly due to the flood of liquidity infused by central banks and markets’ proclivity to price-in future prospects instead of the more obvious present.

In India, the movement of the market benchmarks has been distorted further due to one stock — Reliance Industries (RIL).

Mukesh Ambani made the most of the lull in business activity during the lockdown to unleash a blitzkrieg of stake sales in RIL’s digital arm Jio Platforms and now its retail arm, Reliance Retail Ventures, too. This made investors swarm to the stock.

The RIL stock, that already enjoyed the highest market capitalisation in the Indian market, has gained over 100 per cent since April, increasing its weight in the Nifty 50 to over 13 per cent. The behemoth also represents 10 per cent of the total Indian market capitalisation now.

A third of the gain in Nifty 50 since April is thanks to RIL.

Most of the action in Reliance Industries stock happened after 2017 and it actually began this decade on a rather sedate note, with market capitalisation of ₹3.4 lakh crore in March 2011.

This amounted to around 5 per cent of the total market capitalisation. But at the current market-cap of ₹15.23 lakh crore, the stock accounts for almost 10 per cent of the value of all listed shares.

Too big for comfort?

How did this happen? The last 10 years have been ground-breaking for RIL as it made all the right moves — increasing focus on consumer facing businesses, telecom and retail — and reducing the focus on energy.

Its heavy investments over the past decade increased its gross fixed assets from ₹2.2 lakh crore to almost ₹5 lakh crore, with a large chunk invested in telecom.

Investors were initially sceptical about the telecom foray and the RIL stock hibernated between ₹400 and ₹500 from 2009 to 2016.

But the launch of Reliance Jio in early 2017 and the rapid inroads into the telecom sector, grabbing a third of the market share in no time, laid all doubts to rest, and the stock gained around 200 per cent between 2017 and 2019. While it did decline 33 per cent in March in the pandemic-induced sell-off, it was at a new life-time high by June and has currently gained over 113 per cent since March.

The slew of stake sales in Jio Platforms and now the renewed excitement with stake sales in the retail venture are keeping the momentum going.

The market cap of RIL in January this year was ₹9.56 lakh and accounted for around 6.4 per cent of the total market cap. The share remained the same towards the end of March as well, at 6.2 per cent. It’s the breakneck rally over the last six months that has expanded RIL’s market with the rights issue in May contributing to the expansion.

Distorting the index

Both the Indian benchmark indices, the Nifty 50 and the Sensex, are calculated based on free-float market capitalisation of the most traded stocks in the market.

Both benchmarks are far from perfect. One, they are too narrow, with only a handful of the over 2,000 actively traded stocks in the market. Two, since the stock selection is based on trading activity and market cap, the sectoral representation in the indices is far removed from the underlying economy.

Also, since the index constituents are the largest companies in the country, they do not reflect the difficulties in the unorganised or MSME sectors.

The stellar gains made by stocks in the benchmark indices, since March lows, clearly do not reflect the pain in most parts of the economy. The gargantuan size of RIL’s market share is further distorting the picture.

Towards the end of August, the weight of RIL in Nifty 50 was 13.6 per cent. A stock this large that is on an upward spiral is driving the benchmarks crazy too.

Consider this: the Nifty 50 has gained 46 per cent from the March lows. If we assume that RIL’s stock price had remained unchanged since March, the index return will whittle down to around 30 per cent.

It’s true that RIL is truly a behemoth, with its FY20 revenue amounting to 1.8 per cent of India’s nominal GDP. But the stock market is ascribing a far higher value to the stock based on future expectations that may not prove right.

Investors are currently betting on stellar success of the apps owned by Jio Platforms and the e-commerce business trumping global majors such as Amazon.

Any disappointment on these fronts could lead to valuation returning to more earthy levels, which can drag down the stock price and, unfortunately, the market also along with it.

What’s the way out?

One way to check the anomaly of a single stock skewing the index is through caps on individual stock weights.

Many indices such as the Nasdaq 100 follow this method, wherein the weight of each constituent is capped at a certain level. If the limit is crossed, the excess weight is redistributed among other constituents.

Of the NSE indices, most of the sectoral, thematic and strategy indices have such caps on stock weights. For instance, in the Nifty PSU Bank index, no single stock can have weight more than 33 per cent and weights of the top three stocks cumulatively cannot exceed 62 per cent.

But broad-based indices such as Nifty 50 do not have such caps. Given the ongoing experience with the RIL stock, SEBI could consider prescribing limits on weights in important benchmarks such as the Sensex and Nifty 50. The individual stock weight should however be sufficiently high, at perhaps 20 per cent

The other problem with our benchmarks is that they are too narrow. While we are used to tracking the Nifty 50 or the Sensex, focus can be shifted to broader benchmarks such as the Nifty 500 where such concentration risk is lower. It is also time to popularise equal-weighted indices that can negate the concentration issues.

Lastly, it is time to align the limits set for mutual fund schemes in individual stocks with the weights in the scheme benchmarks. It does not appear fair to have no limit on stock weights in indices whereas mutual fund schemes are allowed to invest only up to 10 per cent of the NAV of a scheme in any stock.

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