The Execs and Cons of Equal Weight Indices

Equal weight indices are in vogue. You could have observed recent index fund launches from numerous AMCs.

On this publish, allow us to have a look at a number of the good and not-so-good factors about equal weight indices. We are going to see how equal weight indices have carried out during the last 2 a long time in comparison with the market-cap primarily based indices.

Sharing briefly at the start. Will talk about the nuances later.

Cap-Based mostly Indices Vs Equal Weighted Indices

In a market cap-based index (Nifty 50, Sensex, Nifty Subsequent 50, Nifty Midcap 150), a inventory with the next free-float market cap will get the next weightage within the index.

In an equal weight index, all of the shares have the identical weightage. Sure, the weights could change primarily based on the efficiency of constituent shares however are rebalanced to the identical weight on the rebalancing date.

For example, Nifty 50 Equal Weight index, weights of all of the shares within the index can be rebalanced to 2% on the date of rebalance. The index is rebalanced semi-annually on the final working day of March and September.

With a market-cap primarily based index, the weightage of a inventory will enhance (lower) with good (dangerous) efficiency of the inventory. The allocation to rising shares will enhance. This may occur in an EW index too, however the portfolio will reset to equal weight on the portfolio rebalancing date.

In an EW index, the cash would transfer from better-performing inventory to an underperforming inventory on the rebalancing date. This makes extra of a “Worth” play. Market-cap primarily based indices let the shares journey the “momentum”.

#1 Diversification

With a market-cap primarily based index, outperformance in a single or few prime shares can supercharge the index returns. Equally, the under-performance of some prime shares could make all the index undergo. This is not going to occur in an equal weighted index.

Equal weight indices are prone to be extra diversified, as a single inventory (or a couple of shares) will be unable to hijack all the index. EW indices are prone to have a greater diversified trade publicity.

Take into account trade and constituent-wise break up for Nifty 50.

Supply: Factsheets for respective indices on NiftyIndices.com. Information as on July 31, 2024

Now for Nifty 50-Equal Weight.

Within the cap-based Nifty 50 Index, the weightage of prime shares is kind of excessive.

In Nifty 50 Equal weight, the weightage of inventory is near 2%. Will get again to precise 2% on the rebalancing date.

Therefore, on the diversification entrance, equal weight indices appear to attain over cap-based indices.

#2 Liquidity

When a inventory’s free-float market cap is greater, it’s cheap to besides that the inventory will even be liquid i.e., you could possibly purchase and promote the inventory at a low influence value. Bid and ask costs could also be nearer. The liquidity in a inventory is vital as a result of the fund supervisor wants to purchase and promote inventory to handle purchases and redemptions.

Whereas in a cap-based index, the fund supervisor should purchase in proportion of their market cap. For example, if a fund supervisor should deploy Rs 10 crores in a Nifty index fund, he/she should make investments say about 1.1 crore every in HDFC Financial institution, 94 lacs in Reliance Industries and so forth. These quantities are primarily based on weights as on July 31, 2024.

Nonetheless, in an equal-weight index, the fund supervisor should purchase all of the shares for a similar quantity. 20 lacs in every of the shares in Nifty 50.

Now, this liquidity is probably not an issue for Nifty 50 Equal Weight. However there are different equal weight indices as properly.

Take into account Nifty 500 Equal Weighted index.

Would the inventory which ranks between 450 and 500 by way of market cap have the identical liquidity and volumes as Reliance Industries, HDFC Financial institution, or Infosys? However the fund supervisor should purchase/promote all these shares for a similar quantity. It’s an equal-weighted index. Would that enhance monitoring distinction?

Market cap-based indices deal with these points by design. The allocation is dependent upon the free float market cap. An even bigger inventory will get the next allocation. And a small inventory will get a decrease allocation. No such luxurious in equal weight indices.

Therefore, in case you are concerned with an equal weighted index, do control the monitoring distinction.

#3 Publicity

What does a Nifty 500 index fund offer you publicity too?

Provides you publicity to virtually all the market spectrum. Massive cap, midcap, and small cap. Right here is the classification of shares as per SEBI definition.

Massive cap: 1-100^th inventory by market cap

Midcap;101^st-250^th inventory by market cap

Small cap: 251^st-500^th inventory by market cap

What doesn’t a Nifty 500 Equal Weight index offer you publicity to?

To the identical set of shares. High 500 shares.

Whereas the shares are the identical, the allocation to the big, midcap, and small cap indices is drastically completely different.

Nifty 500: Massive cap: ~72%, Midcap: ~17%, Small cap: ~10%

Nifty 500 Equal Weight: Massive cap: 20%, Midcap: 30%, Small cap: 50%

Information as on July 31, 2024. Supply: Nippon AMC presentation

Disclaimer: The securities proven above should not recommendatory.

Nifty 500 appears extra like a big cap or a multicap fund.

Nifty 500 Equal Weight is extra like a mid and small cap fund.

I’m not implying that the Nifty 500 index is healthier than Nifty 500 Equal Weight index or vice versa. Merely saying that these are 2 vastly completely different funds and offer you vastly completely different inventory market publicity.

No matter how indices have carried out prior to now, there can be instances sooner or later when Nifty 500 will outperform. And there can be instances when Nifty 500-EW will outperform Nifty 500. When there’s a broader market rally and mid and small cap shares are outperforming, you may anticipate Nifty 500-EW to carry out higher.

When the big caps are outperforming, Nifty 500 will doubtless beat Nifty 500-EW.

And earlier than you spend money on any product, it’s essential to understand how your cash have to be invested.

How have Equal Weight Indices fared?

All this info is okay, however how these EW indices have fared in comparison with fashionable market-cap primarily based indices.

I’ve picked up outstanding equal weight and market cap-based indices for the comparability.

1. Nifty 50
2. Nifty 50 Equal Weight
3. Nifty 100
4. Nifty 100 Equal Weight
5. Nifty Subsequent 50
6. Nifty Midcap 150
7. Nifty Smallcap 250
8. Nifty 500
9. Nifty 500 Equal Weight

I’ve used month-end knowledge from April 1, 2005, till August 31, 2024.

I’ve used Worth index knowledge (PRI) for comparability. And never Complete Returns index. Please perceive you can not spend money on the index fund straight. You could make investments by the use of index funds or ETFs. Therefore, whereas evaluating, it’s essential to control the expense ratio and the monitoring distinction.

Whereas evaluating any funding on your portfolio, it’s essential to additionally attempt to see when these merchandise have outperformed.

Since we’re talking about equal weight indices, it is advisable see if the outperformance of equal weight indices comes when smaller shares have performed properly. This may doubtless be the case as properly. For example, a approach to view the efficiency of Nifty 50 and Nifty 50 Equal Weight is to evaluate together with the efficiency of Nifty Subsequent 50 index. I do know this isn’t the proper approach to consider efficiency. The rationale I picked Nifty Subsequent 50 is as a result of it has shares simply outdoors of Nifty 50 and smaller than Nifty 50 shares.

I’ll depart this knowledge to your interpretation.

Nifty 50 vs Nifty 50 Equal Weight

As mentioned above, bringing in Nifty Subsequent 50 for comparability too.

Nifty 100 vs Nifty 100 Equal Weight

Since Nifty 100 index contains of shares in Nifty 50 and Nifty Subsequent 50 index fund, I’ve added these funds for comparability too.

Nifty 500 vs Nifty 500 Equal Weight

Since Nifty 500 Equal weight has 30% midcap and 50% small cap shares, I’ve added these indices too for comparability.

You’ll be able to discover that Nifty 500 Equal Weight outperforms when the midcap and small cap indices have performed properly. You’ll be able to verify this from calendar yr returns too. Alongside anticipated strains.

Must you spend money on Equal Weight indices?

There isn’t a black and white reply to this query. Is dependent upon your desire and the way you wish to use these in your portfolio. For example, an investor can mix Nifty 500 and Nifty 500 Equal Weight in a particular ratio portfolio to get the specified allocation to giant, midcap, and small cap funds within the portfolio.

In the event you plan to spend money on an equal-weight index fund, it’s essential to take into account the next facets.

1. Don’t simply go by fancy presentation by AMCs. Perceive sort of publicity the EW index fund presents.
2. Take into account previous efficiency. Whereas previous efficiency shouldn’t be an indicator of future efficiency, attempt to see if you will get the expertise of EW index fund by mixing 2 cap-based indices. By expertise, I imply each returns and volatility.
3. You don’t spend money on the index. You spend money on index funds and ETFs. Take into account expense ratio and monitoring distinction
4. Assess if the equal weight index fund provides enough worth to warrant one other fund within the portfolio.

Passive investing is selecting up in India. Therefore, anticipate AMCs to launch new concepts frequently, however you can not make investments all over the place.

Have you ever invested in Equal Weight indices? If sure, which one and why? Do let me know within the feedback part.

Disclaimer: Registration granted by SEBI, membership of BASL, and certification from NISM on no account assure efficiency of the middleman or present any assurance of returns to buyers. Funding in securities market is topic to market dangers. Learn all of the associated paperwork rigorously earlier than investing.

This publish is for training function alone and is NOT funding recommendation. This isn’t a advice to take a position or NOT spend money on any product. The securities, devices, or indices quoted are for illustration solely and should not recommendatory. My views could also be biased, and I’ll select to not concentrate on facets that you simply take into account vital. Your monetary targets could also be completely different. You might have a special danger profile. Chances are you’ll be in a special life stage than I’m in. Therefore, it’s essential to NOT base your funding selections primarily based on my writings. There isn’t a one-size-fits-all answer in investments. What could also be a very good funding for sure buyers could NOT be good for others. And vice versa. Subsequently, learn and perceive the product phrases and situations and take into account your danger profile, necessities, and suitability earlier than investing in any funding product or following an funding strategy.