Index funds that eliminate the risks in fund manager’s stock selection have been gaining investor attention in the past few years. This is because of the underperformance of many actively managed large-cap funds against their benchmarks such as the Nifty 50 TRI and the Nifty 100 TRI.
As there is no active selection of stocks by the fund manager, unsystematic risk (pertaining to selection of companies, sectors, etc) in index funds is low.
Lower expense ratios than actively managed equity funds, adds to their attraction.
Equal weight index funds
Index funds try to replicate the performance of their underlying benchmarks.
They imitate the portfolio of an index (say, the Nifty 50) by investing in stocks that are part of it in the same proportion as they are in the index. Equal weight index funds, however, place no importance on weights allocated to individual stocks in an index.
These funds allocate equal weights — while investing — to all the companies in an index.
Most indices tend to assign weights based on the market capitalisaton of their constituents.
No allocation bias
By assigning equal weight, these funds are eliminating the bias in allocation arising from the size of a company.
Currently, three equal weight index funds are available in the market.
DSP Equal Nifty 50 Fund tracks the Nifty 50 Equal Weight index as the benchmark, while Principal Nifty 100 Equal Weight Fund and Sundaram Smart Nifty 100 Equal Weight Fund track the Nifty 100 equal weight index as their benchmark.
These funds aim to achieve returns commensurate with their respective indices.
The equal weight indices are more evenly distributed across different sectors.
For instance, the top 10 stocks in the Nifty 50 index constitute about 60 per cent of its portfolio spreading across four sectors.
Meanwhile, the top 10 stocks in the Nifty 50 Equal Weight index constitutes just 20 per cent of the portfolio diversifying across six sectors. The weights are realigned once every quarter.
Over the past one, three and five years, the above said equal weight indices have underperformed their respective market-cap weight indices.
During these periods, the Nifty 50 Equal Weight index (TRI) registered -34 per cent, -9 per cent and -4 per cent compounded annualised returns (CAGR), while the Nifty 50 TRI delivered -30 per cent, -3 per cent and 0.1 per cent returns.
The trend is similar in the Nifty 100 Equal Weight index (TRI), too, which clocked a CAGR of -31 per cent, -8 per cent and -2 per cent, whereas the Nifty 100 TRI yielded -29 per cent, -3 per cent and 0.5 per cent, respectively, during these periods.
However, rolling return data show mixed results. Rolling return tells you the consistency of a fund’s performance. Five-year rolling returns calculated from the past seven years’ NAV history show that the Nifty 50 Equal Weight index TRI delivered 8.7 per cent CAGR, while the Nifty 50 TRI registered 11.4 per cent.
Meanwhile, the Nifty 100 Equal Weight index TRI clocked a return of 11.4 per cent and tried to match with the return of the Nifty 100 TRI’s 12 per cent.
Apart from returns, the efficacy of index funds is identified through tracking error (TE), which measures how closely an index fund tracks its chosen index. Daily TE calculated from the last two years’ NAV was 0.07 per cent, 0.08 per cent and 0.06 per cent for DSP Equal Nifty 50, Principal Nifty 100 Equal Weight and Sundaram Smart Nifty 100 Equal Weight, respectively.