Mutual Funds

Why Nifty Next 50 index fund is a good investment

Maulik Madhu BL Research Bureau | Updated on April 17, 2021

More diversified, less concentrated than Nifty ; But be ready for short-term volatility

With many actively managed funds underperforming their benchmark indices, investors have been drifting towards the relatively low-cost index funds. Those who can digest short-term volatility in return for higher long-term returns can consider investing in the Nifty Next 50.

What is it

The Nifty Next 50 is composed of the next 50 largest companies by market capitalisation after the Nifty 50 companies. With a 38 per cent weight to Financial Services, the Nifty 50 is heavily skewed towards this one sector. IT and Oil & Gas account for another 16.8 per cent and 11.8 per cent, respectively. The Nifty Next 50, on the other hand, has a less concentrated sector distribution. The top three sectors, Consumer Goods, Financial Services and Pharmaceuticals, account for 18.5 per cent, 17 per cent and 11 per cent, respectively of the index.

In terms of individual company weights too, the Nifty Next 50 is less concentrated. The top five stocks constitute a little over 17 per cent of the index. On the other hand, HDFC Bank and Reliance Industries make up over 20 per cent of the Nifty 50.

 

Higher returns

The Nifty Next 50 has outperformed the Nifty 50 across different investment time frames — three-, five- and seven-year periods — over the past 25 years, based on a rolling return (CAGR) analysis. The Nifty Next 50 has delivered on average, 3-year return of 16.6 per cent (vs 12.0 per cent for Nifty 50), 5-year return of 17.6 per cent (vs 12.0 per cent for Nifty 50) and 7-year return of 19.3 per cent (vs 12.6 per cent for Nifty 50) over this period.

Average returns can mask instances of under-performance. But that’s not so for the Nifty Next 50. Data shows that the Nifty Next 50 has had more instances of 3-, 5- and 7-year returns (CAGR) greater than, say, 12 per cent and 15 per cent than the Nifty 50 (see table).

Greater risk

The higher returns of the Nifty Next 50 have, however, been accompanied by greater volatility in the interim. One must, therefore, be prepared for sharper falls of the Nifty Next 50 in between and stay invested longer (five years or more).

Downside capture ratio: It provides a snapshot of the extent of an index’s fall when the broader markets fall. A downside capture ratio of 109 per cent (greater than 100 per cent) for the Nifty Next 50 with reference to Nifty 50 implies that the former has fallen more than Nifty 50. The Nifty Next 50 has, however, also captured more of the upside (upside capture ratio of 114 per cent) in periods when the markets rose.

Maximum drawdown: The Nifty Next 50 has shown steeper drawdowns than the Nifty 50. The chart plots the daily returns for the two indices. It shows the extent of daily fall in each index compared to its previous peak until then. As can be seen from the chart, the Nifty Next 50 has fallen more than the Nifty 50 several times. This is particularly evident on dates such as September 21, 2001 (September 11 US attack) and March 9, 2009, the sub-prime crisis market bottom.

Index fund options

Once you decide you want exposure to the Nifty Next 50 companies, you need to pick an index fund tracking this index. Go for an index fund with a lower expense ratio and tracking error, few years’ record and a reasonably-sized AUM. The tracking error (TE) shows the extent to which the returns of a fund diverge from those of its benchmark index (here, the Nifty Next 50 TRI). There are seven Nifty Next 50 index funds available, including the recently launched one by Kotak MF. Among the large ones, UTI Nifty Next 50 Index Fund has an expense ratio of 0.34 per cent under direct plan and TE of 0.08 per cent (last one year). The significantly smaller L&T Nifty Next 50 Index Fund has an expense ratio of 0.25 per cent and TE of 0.10 per cent.

Published on April 17, 2021

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