If someone wants to allocate equal amounts to a Nifty 50 index fund and a Nifty Next 50 index fund, then is it better to allocate that amount to a single Nifty 100 index fund? This was a query we received from a subscriber, and one we thought would be interesting for you to know as well. After all, the Nifty 50 and the Nifty Next 50 anyway add up to the Nifty 100 so wouldn’t it amount to the investing in same thing?
Here’s the answer – no. Investing separately in the Nifty 50 and the Nifty Next 50 is not equal to investing only in the Nifty 100. You will have different returns by holding the Nifty 100 alone versus a Nifty 50-Next 50 combination. The reason lies in the index construction and stock weights. And it’s not just that.
Weights make the difference
Stocks in each of the indices is weighted on its free-float market capitalisation. Given that each of the indices has a different set of stocks, the weights of each stock in the index will differ. The weights of individual stocks of the Nifty 100 will not be the sum of Nifty 50 and Next 50.
Look at the table below. It shows the top 10 stocks in the Nifty 50 and the Nifty Next 50 (based on the free-float market cap) and their corresponding weight in the Nifty 100. For example, Reliance Industries holds a 12.4% weight in the Nifty 50, and a 10.6% weight in the Nifty 100.
Why does this make a difference? Because Reliance Industries’ returns influence on the Nifty 50 will be greater than its effect on the Nifty 100. Look at the last column in the table. It shows the return each of the top ten stocks generated in the past 1 year.
Now consider the Nifty Next 50. It houses the 50 largest stocks after the Nifty 50. But in the Nifty 100, because their market capitalisations are lower than the Nifty 50, the Next 50 stocks account for a far smaller weight in the Nifty 100. Avenue Supermart’s outsized returns helps propel the Next 50’s returns but will not budge the Nifty 100 by much.
A look at the sector weights of each index also shows that each index is different. Financial services, for example, is a high weight in all three indices – and therefore, mixing the Nifty 50 and the Next 50 will give a very different exposure to the sector than the Nifty 100 alone.
Returns are different
As you have now realised, the outcome of the Nifty 50 + Next 50 will not be the same as the Nifty 100.
To see the effect on returns, consider the timeframe from December 2004 to date. We’re taking this period since it’s the earliest date from which we have uniform periods for all three indices.
- In this period, the Nifty 50 and the Nifty 100 seem to be closer overall on returns. Average of the 3-year returns rolled daily for the two indices stands at 10.5% and 10.9% respectively.
- Over 5-year rolling periods, the Nifty 50’s 12.3% closely matches the Nifty 100’s 12.9%.
- The Nifty 100, though, is able to eke out such slim gains over the Nifty 50 more often than not. For example, on a 3-year basis, the Nifty 100 outperformed the Nifty 50 close to 70% of the time. On a 5-year basis, the index beat the Nifty 50 80% of the time.
The Next 50 is wholly different.
- The average 3-year returns hold much stronger at 13.3% and the average 5-year returns are at 15.5%.
- It beats the Nifty 50 and the Nifty 100 70-80% of the time on a 3-year and 5-year basis. The reasons behind this index’s performance is explained here.
Behaviour is different
But before you leap onto the Next 50 train, know that each index itself behaves differently and requires different risk levels. While the index’s performance catches your eye, there are other metrics to consider which will influence the index’s suitability for you and the share it should have in your portfolio.
One, the volatility. On this count, the Next 50 is much more volatile than either the Nifty 50 or the Nifty 100. The dips and rises of the Next 50 are steeper than the Nifty 50 or the Nifty 100. Measured by standard deviation, the Next 50 is the most volatile index across all timeframes, whether 1 month or 3, 1 year or 3 years or 5, followed by the Nifty 100.
Two, the downsides. Bigger falls need bigger recoveries in order to deliver overall long-term returns for your portfolio. Because of its higher volatility, the Nifty Next 50 tends to suffer from bigger falls compared to either of the other two indices.
For example, on a 1-year rolling basis (same period as above), the Next 50 delivered losses 31% of the time with its steepest loss coming in at 67%. The Nifty 100, on the other hand, delivered losses 26% of the time, similar to the Nifty 50.
Three, the tracking error and expense ratio are not the same between the index funds – so you can have a Nifty 100 with a low tracking error and a Nifty 50/Next 50 with high tracking error or expense ratios. Expense ratios are also marginally higher in indices outside the Nifty 50 while newer index funds have higher expense ratio.
So, given all this how should you use these indices?
- Each large-cap index has a different return and risk profile. The index you should go for depends on your requirement. For example, if all you need is a simple large-cap index to substitute large-cap funds, just the Nifty 100 will do.
- If you’re splitting allocations between indices, know that you do not need to do such allocations evenly between the indices. Use different weights for each index based on the risk you are willing to take. For example, you can have a higher share to the Nifty 50 or the Nifty 100 and lower to the Next 50 if your risk level is more conservative.
- If you already have active multi-cap or mid/small-cap funds and whose strategies do not help in containing downsides well or are highly volatile, your index fund behaving in a similar fashion may not counter active fund risks. Therefore, ensure that your index fund complements other funds in your portfolio.
Reference: Nifty Indices website