What does the latest round of Nifty changes mean for markets?
The latest round of Nifty changes has been announced and will take effect from the day after the September F&O expiry. As part of the Nifty shift, two stocks will be added to the index and two stocks will be removed. Divi’s Laboratories and SBI Life Insurance will be added to the Nifty 50 index while Zee Entertainment and Bharti Infratel will be removed from the index. It is estimated that the index shift will infuse Rs.1400 crore into Divi’s Laboratories and SBI Life put together, while it will result in outflows to the tune of Rs.650 crore from Zee Entertainment and Infratel. These fund flows will be largely from domestic index funds and index ETFs that are pegged to the Nifty index.
Is Nifty representative?
To a large extent, the Nifty has been representative of the Indian economy. For example, with the rising importance of the services sector in the Indian economy, these services represent over 55% of the Nifty Market cap, which is fair. Insurance was not represented in the index and the inclusion of HDFC Life and now SBI Life, bridges that gap to some extent. But the removal of Zee means that the media sector has just no representation in the Nifty now. One argument is that the Nifty hardly gives a picture of the real economy, which is the reason the Nifty continues to do so well even when the economy is on the throes of a major contraction. These are some issues to really consider.
Are indexes a value trap?
If you look at the performance of Indian equity funds, they have mostly done worse than the Nifty in the last 3 years. The reasons are not far to seek. Indices are being driven by Kurtosis where a handful of stocks like RIL, TCS, HUL, Infosys, HDFC Bank and Bharti can have an inordinately high impact on the Nifty. But equity funds are constrained by the fact that SEBI regulations stipulate that they have to be structurally diversified and that results in underperformance by these funds. The irony is that the index, which is supposed to be a diversified portfolio, itself becomes a concentrated portfolio weighted by market cap. The question is whether such an index is truly representative? This is a key issue as Nifty is the accepted benchmark in most cases, for measuring returns.
An issue of consistency
In the last 25 years of the Nifty, it has seen a total of 180 changes. The Dow Jones Industrial Average (DJIA) over the last 92 years since inception has seen just 60 changes. Clearly, the Nifty looks far from consistent when compared to the Dow. Unless the index is relatively more consistent, it becomes very tough to have an index that is comparable across time periods. Despite all these tweaks to the index, the Nifty-50 has given CAGR returns of just 9.5% in the last 25 years. That is food for thought for the index committee too.
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