The Professionals and Cons of Equal Weight Indices

Equal weight indices are in vogue. You should have seen contemporary index fund launches from varied AMCs.

On this publish, allow us to take a look at among the good and not-so-good factors about equal weight indices. We’ll see how equal weight indices have carried out over the past 2 many years in comparison with the market-cap based mostly indices.

Sharing in short originally. Will talk about the nuances later.

Cap-Primarily based 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 might change based mostly 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 based mostly index, the weightage of a inventory will improve (lower) with good (unhealthy) efficiency of the inventory. The allocation to rising shares will improve. This can 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 based mostly indices let the shares trip the “momentum”.

#1 Diversification

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

Equal weight indices are more likely to be extra diversified, as a single inventory (or just a few shares) won’t be able to hijack the complete index. EW indices are more likely to have a greater diversified business publicity.

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

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

Now for Nifty 50-Equal Weight.

Within the cap-based Nifty 50 Index, the weightage of high 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 increased, 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 impression value. Bid and ask costs could also be nearer. The liquidity in a inventory is necessary 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 based mostly 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 will not be 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 when it comes to 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 improve monitoring distinction?

Market cap-based indices care for these points by design. The allocation depends 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, if you’re interested by an equal weighted index, do keep watch over the monitoring distinction.

#3 Publicity

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

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

Giant 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 massive, midcap, and small cap indices is drastically completely different.

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

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

Knowledge 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 previously, there can be occasions sooner or later when Nifty 500 will outperform. And there can be occasions when Nifty 500-EW will outperform Nifty 500. When there’s a broader market rally and mid and small cap shares are outperforming, you possibly can anticipate Nifty 500-EW to carry out higher.

When the massive 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 standard market-cap based mostly indices.

I’ve picked up distinguished 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 information from April 1, 2004, till August 31, 2024.

I’ve used Value index information (PRI) for comparability. And never Complete Returns index. Please perceive you can’t spend money on the index fund instantly. You should make investments by the use of index funds or ETFs. Therefore, whereas evaluating, it’s essential to keep watch over the expense ratio and the monitoring distinction.

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

Since we’re talking about equal weight indices, you might want to see if the outperformance of equal weight indices comes when smaller shares have performed properly. This can doubtless be the case as properly. For example, a technique 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 technique to consider efficiency. The explanation 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 go away this information 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 includes 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 test this from calendar yr returns too. Alongside anticipated strains.

Do you have to spend money on Equal Weight indices?

There is no such thing as a black and white reply to this query. Relies on your choice and the way you need to use these in your portfolio. For example, an investor can mix Nifty 500 and Nifty 500 Equal Weight in a selected ratio portfolio to get the specified allocation to massive, midcap, and small cap funds within the portfolio.

For those who plan to spend money on an equal-weight index fund, it’s essential to contemplate the next features.

1. Don’t simply go by fancy presentation by AMCs. Perceive form of publicity the EW index fund presents.
2. Take into account previous efficiency. Whereas previous efficiency just isn’t an indicator of future efficiency, attempt to see if you may 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 ample 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’t make investments in every single 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 by no means assure efficiency of the middleman or present any assurance of returns to traders. Funding in securities market is topic to market dangers. Learn all of the associated paperwork rigorously earlier than investing.

This publish is for training goal alone and is NOT funding recommendation. This isn’t a suggestion 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 could select to not give attention to features that you just contemplate necessary. Your monetary targets could also be completely different. You will have a unique danger profile. You might be in a unique life stage than I’m in. Therefore, it’s essential to NOT base your funding choices based mostly on my writings. There is no such thing as a one-size-fits-all answer in investments. What could also be a very good funding for sure traders might NOT be good for others. And vice versa. Due to this fact, learn and perceive the product phrases and situations and contemplate your danger profile, necessities, and suitability earlier than investing in any funding product or following an funding method.