Can I avoid Nifty and invest 50% in Nifty Next 50 index and 50% debt?

Published: October 12, 2020 at 11:59 am

A combination of Nifty (N50) and Nifty Next 50 (NN50) index funds is enough for investors to create a well-diversified equity portfolio – large cap heavy (more of Nifty) or a midcap-heavy (significant exposure to Nifty Next 50). What if one avoids Nifty and invests 50% in Nifty Next 50 and 50% in debt? This is the question posed by S. Nanda.

He writes: I am a 28 years old guy with an investment time period of more than two decades. I don’t know how aggressive I am, as I started my investment journey on 18th May 2020. But I am confident I will invest with discipline and rebalance every year once( starting from 3rd year of my investment ). From the first month of my investment journey, I had the issues of “Dependency on Fund Manager in future”. After reading your videos and articles on the NN50 + N50 blend, I think I found the most powerful and flexible self-adjustable portfolio to invest. ( Along with rebalancing every year ).

I have one query : What if we invest in NN50 only as 50% of my portfolio and rest 50% in debt funds for the next few years.The high volatility can be used as a blessing in disguise by rebalancing and buying more at sharp dips( as that happened in March 20). Once my investment time period decrease with age , I will Regularly shift to fixed assets. I am mentally prepared to stay invested with discipline even if the NN50 portfolio dips 80 % after 10 years. Is it going to be useful sir or should I stick to 60% ( Nifty 50 + NN50 blend) and 40 % debt funds. The issue is nothing works all the time.

At 28, not many would emphasis on portfolio rebalancing as much as you have and not many would recognise the difficulty with depending on “good” fund managers.  Congratulations, you are on the right path and since you have 20+ years before you need the money, you have the time to take risks, live and learn for at least the next few years, say before your first rebalance.

One of the most important lessons in stock investing is liquidity. A fund manager should be able to buy and sell large quantities of any stock in the index with reasonable ease. This means, there sholdn’t be an unnaccetably large difference between the buying and selling price. Retail investors will never experience this as are only going to buy/sell in small quantities. This is referred to as an impact cost.

If buy/sell price for bulk orders significantly delviates from the “fair market price” there is a loss that cannot be ascribed to “expenses or fees”. Higher the impact cost of a cost, more the price depends on the quantity sold, lower the liquidity and higher the drawdown risk. That is, price could fall steeply during a sell-off or zoom during a buy-in

If you look at the Nifty 50 stocks (Sep 2020, Source NSE Monthly reports), the min impact pact is 0.020%; max is 0.040%; median 0.030% and average 0.029%. That is a reasonably tight spread with not much difference bet the median and average.

Head over to the Nifty Next 50, the min impact cost is 0.030%, max 1.940%, median 0.040%, average 0.085%.  Only 11 stocks of NN50 have an impact cost lower than the maximum impact cost for Nifty 50 stocks. Although this does not directly affect daily volatility, it makes NN50 susceptible to bigger falls.

As Nanda argues  (not in so many words) this also means bigger upmoves. The problem is, a market crash is not the biggest risk for an investor. Consider the trailing returns ICICI Nifty and Next Next 50 index funds (don’t worry about the UTI twins, this is not about TER or tracking error)

TenureICICI Pru Nifty Index Fund(G)-Direct PlanICICI Pru Nifty Next 50 Index Fund(G)-Direct Plan
1 Year5.952.70
2 Years8.403.83
3 Years6.83-0.64
4 Years8.924.39
5 Years8.567.26
6 Years7.748.75
7 Years10.9313.19

One can argue out reasons for the poor performance of NN50 but that is going to help anyone get more returns or avoid losses. When one sees a table like this, it is tempting to point out – look, NN50 did better over 6 and 7 years. This is naive to say the least.

A NN50 investor who started in Oct 2017 would be staring at a loss now. If think “SIP” would have helped – not by much. Trailing 3y NN50 SIP return is 0.18% comapred to 7.14% for the Nifty. A return of 0.18% in equity is a loss  becuase the risk has not been compensated enough! Do you think such investors should simply keep investing only in the NN50 for another four years because “in the past NN50 outdid N50 over 7 years?” Or do you think they should spread their bet and at least include 50% of Nifty in their equity portfolio?

A poor sequence of returns such as the one above can destory wealth and time irreversibly much more than a 80% dip in the portfolio. Remember large downswings will be quickly followed by upwsings and vice versa. See: Timing the market will work but not the way we imagined! Also: 150% profit but only 9.6% return?! Why you should fear sideways markets.

It is not about whether you can emotionally handle a big fall or not (everyone is taught how to behave when a lion is staring at us in the forest, it is what we do when that acutally happens that matters). It is about whether your financial needs can handle such a fall. Rebalancing is good, but it is not a cure for taking on more risk.

If you were 20 or 22, I would have said, invest in 50-60% NN50 and rest in debt for at least a few years live and learn and then course correct. Sadly 28, I hate to break it to you, is just a stones throw away from middle-age ( = 30s not 40s!). So please stick to 30% N50 + 30% NN50 + 40% debt. Why? “The issue is nothing works all the time”.

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About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association, IIST Alumni Association. For speaking engagements write to pattu [at] freefincal [dot] com
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