A 500-stock index is typically expected to offer wide diversification to investors, but the Nifty 500 index has a large-cap bias. However, a recently launched rule-based fund—the Nippon India Nifty 500 Equal Weight Index Fund–aims to give broader diversification across large-, mid-, and small-cap stocks.
How it works
Instead of market-cap weights, the fund will maintain an equal weight across the 500 stocks in the index. So, each stock will get a weight of 0.2%. This would lead to an index composition with 20% exposure to large caps, 30% to mid caps, and 50% to small caps.
This is quite different from the regular Nifty 500 index, where 72% of the index is exposed to large-cap stocks—the top 100 stocks by market capitalization.
The equal-weight index reduces concentration in the financial services sector to 18% compared to 27% in the traditional Nifty 500 index, allowing for increased exposure to other sectors. The large exposure to financials in the regular index is due to the dominance of this sector in terms of market capitalization in Indian stock markets.
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“For an investor looking for a passive approach to investing in stock markets, with a well-diversified portfolio across market caps, this can be an alternative,” said Arun Sundaresan, head, exchange traded funds, Nippon Life India Mutual Fund.
Risk vs returns
The Nifty 500 equal-weight index has delivered annualized returns of 30% over the last five years, vis-a-vis 22% returns delivered by the regular Nifty 500 index. Over a three-year period, the equal-weight index has delivered 25.9% annualized returns against 21% delivered by Nifty 500 index.
In the past year, the equal-weight index has generated 56% returns against the 39% delivered by the Nifty 500 index.
However, this recent sharp outperformance can be attributed to mid- and small-cap stocks outperforming during these periods.
But over longer-term–seven-year and ten-year periods–the returns have been in-line with the regular 500 index.
“While this is an index fund, investors need to understand it is slightly more risky than a regular index fund, as it is an equal weight on a broad-based index like Nifty 500,” pointed out Deepak Chhabria, chief executive officer, Axiom Financial Services. “As the equal-weight leads to reduced exposure to large-caps, it increases exposure to mid- and small-caps. If it was an equal weight on Nifty 100 or Nifty 200, the exposure would have still been restricted to large-caps.”
What doesn’t work
While the equal-weight index has outperformed the regular index in recent periods, the index can see higher volatility than the regular index.
Over one year, its standard deviation is 16.86, while it is 13.7 for the regular Nifty 500 index. Over five years, the equal weight has a standard deviation of 19.09, while it is 18.67 for regular Nifty index.
“Given its large exposure to mid- and small-cap stocks, the fund’s performance could be more cyclical and volatile in nature,” said Rushabh Desai, founder of Rupee with Rushabh Investment Services.
“As the index has just 0.2% to individual stocks, there may be limitations to the extent it can capture upside from run-up in performance of individual stocks. On the other hand, this would also mean the impact of decline from individual stocks is limited, due to the lower weights,” said Chhabria. To be sure, the weights would only get re-balanced on a quarterly basis.
“The fund may miss out when there are sector-specific rallies, as it will keep an equal weight regardless of the sector,” he added.
Should you invest?
Investors seeking broad, diversified exposure to stock markets without a large-cap bias can consider the Nifty 500 equal-weight index fund. However, as a smart beta fund, it sits somewhere between active and passive investing, adhering to a set of rules—in this case, equal weight. Hence, watch out for its performance against a Nifty 500 index fund, which is a pure passive investment strategy.
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