Last Updated on December 29, 2021 at 6:18 pm
HDFC NIFTY50 Equal Weight Index Fund is an open-ended scheme tracking the Nifty 50 Equal-Weight TR Index. In this review, we analyse the performance of the underlying index by comparing it with NIfty 50 and Nifty Next 50 total return indices.
What is an equal-weighted index? The NIfty, Sensex, Nifty 100, Nifty 500 are examples of market capitalization-weighted indices. Typically 60% of the total weight of the Nifty 50 will be among the top 12-13 stocks at any given time. This results in a concentration risk and the index being driven by just a few top stocks. See for example: Return difference of Nifty 50 vs Nifty 50 Equal-weight index at an all-time high!
An alternative approach is to index creation is to weigh the stocks equally. Each stock in the Nifty 50 Equal Weight Index has about 2% weight (at the time of creation), and each stock in the Nifty 100 Equal Weight Index has about 1% weight.
According to the NSE report:
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Equal weight index benefits from better diversification due to lower stock concentration risk as compared to parent index. One of the major benefits of equal weight index strategy is better diversification by avoiding concentration of portfolio in few big stocks.
They also state
Equal weight index strategy tends to have a higher stock weight turnover and higher liquidity constraints during portfolio rebalancing – making replication relatively more cumbersome
Regular readers may be aware of our previous articles on equity-weight indices: Nifty 50 Equal Weight Index vs Nifty 50: Does equal weight result in more returns? And Active Large Cap MFs recover along with equal-weight indices. Investors may have noticed that the Nifty 50 equal-weight index surged past Nifty 50 in the last year due to the market rally.
As of Aug 3rd 2021, the DSP Equal Nifty 50 Fund has a one-year trailing return of 64.90% (it was 81.7% as of March 21st 2021) while the UTI NIfty fund only 49.7%. The DSP fund has the 2nd largest 1Y return (it was first in March). If you look at the since inception evolution of the Nifty 50 Equal Weight Index, it looks impressive compared to Nifty 50.
However, investors must not get carried away by these point to point returns and must look deeper. They must also be careful about fancy arguments made about equal-weight indices. While reviewing Aditya Birla Sun Life Nifty 50 Equal Weight Index Fund a reader altered me to what can only be described as an atrociously misleading writeup in the Financial Express: “Automatic profit booking: Index fund with a difference launched – Check how it works“.
An experienced investor can guess what the article is trying to say: The quarterly rebalancing of the Nifty 50 Equal weight Index results in profits moved from stocks with higher weight to stocks with a lower weight.
If this was the case, the Nifty 50 Equal Weight Index should have consistently outperformed the Nifty 50. This is not the case, as one can see from 5, 10 and 15-year rolling returns data.
In a rolling returns study, we look at every possible return window and not a single window. For example, to compute 15Y rolling returns, we compute the return between 30-06-1999 to 26-06-2014, then roll over the window by one business day to 01-07-1999 to 27-06-2014 and so on. This results in 1787 such windows up to 3rd Aug 2021.
Over five years, there is much difference among the three indices.
10-year returns of the equal weight index have lower than the Nifty 50 since early 2013!
Since Feb 2019, the equal index fund has given a lesser return than the Nifty 50 over 15 years! So much for “long term benefits” of this index and “periodic profit booking”.
The recent uptick in performance in equal-weight indices has been discussed recently: Is it game over for active large cap mutual funds?
The ratio of NIfty 50 Equal-Weight TRI divided by Nifty 50 TRI is shown below. Higher the value of these ratios, the higher the opportunities for choosing performing stocks from beyond the top 15 stocks of NIfty 50.
N50EW/N50 peaked almost ten years ago and has been falling since. After the market crash in March 2020, there was a reversal. See: Market crash destroys imbalance among Index stocks. You may have noticed active large cap funds doing a bit better after the market recovery. This is because opportunities beyond the top few stocks became available again. The ratio is currently still lower than the highs seen 10/11 years ago.
In summary, we recommend that investors avoid the HDFC NIFTY50 Equal Weight Index Fund and any other equal weight index. They can be frustrating to hold. The expenses would be higher, and replicating the index quite difficult (higher tracking error). Instead, the Nifty Next 50 index is a better choice, as can be seen from the above picture. See: Combine Nifty and Nifty Next 50 funds to create large, mid cap index portfolios.
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