Is it time to exit from Nifty Next 50?

Published: March 5, 2022 at 6:00 am

Last Updated on August 22, 2022 at 11:11 pm

Abhijit asks, “Sir, I have been investing in ICICI Nifty Next 50 Index fund for the past three years. I am shocked to learn that the index has failed to beat Nifty for the past 6 years. The higher expense ratio for these funds makes the underperformance even worse. As you have pointed out many times before Nifty Next 50 (NN50) is much more volatile than the Nifty. But we are not getting the returns for this risk. So should I stop investing and exit from ICICI NN50 fund”?

We have mentioned this several times before – The Nifty Next 50 is a weird index. It can provide joy and frustration in equal measure. For the reasons mentioned by Abhijit, it is certainly tough for an investor to keep faith in this index.

The only consolation I can offer is this: (1) 5-Y, 6-year, 7-year and even 8-year underperformance (wrt Nifty 50) is not new! The current underperformance duration is 6-years. So if we compare the rolling returns over this duration, we see thatNN50 can be particularly painful to hold when the market is not moving anywhere.

Six year rolling returns of Nifty Next 50 vs Nifty 50
Six-year rolling returns of Nifty Next 50 vs Nifty 50

This is the movement of NN50 compared with Nifty for the last six years(approx ). NN50 has not yet recovered since it started falling in early 2018.

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Comparison of Nifty Next 50 vs Nifty 50 since May 10 2016
Comparison of Nifty Next 50 vs Nifty 50 since May 10 2016

Even over 10 years, NN50 can go below N50 (if we take into account fees and tracking errors), but there is a reasonable chance of outperformance.

Ten year rolling returns of Nifty Next 50 vs Nifty 50
Ten-year rolling returns of Nifty Next 50 vs Nifty 50

Some people claim NN50 is for “diversification” and its performance should not be compared with the Nifty. This does not make sense to us. The only reason an investor should choose the NN50 is its ability (based on past performance obviously) to beat the Nifty at higher risk.

If this is not happening, then we are only left with a higher risk, defeating any “diversification” benefits. Those who desire such a benefit can consider Nifty 100 (just don’t expect it to beat Nifty often!)

Some complain that Nifty Next 50 carries the rejects of Nifty 50. Such an argument is also not sound. NN50 also has stocks that have graduated from the midcap universe. So it cuts both ways. Although it is market-cap-weighted, the concentration risk in NN50 is significantly lower than the Nifty. It is almost a naturally equal-weighted index.

The top ten NN50 stocks only account for 35.84% of the total weight compared to 58.08% for Nifty. The stock weights are shown below.


So we cannot peg NN50 underperformance (or outperformance) to X stock, or Y stock. Once we open the portfolio of a fund (active/passive) we will always find something to complain about. So it best left closed.

We must also make peace with the fact that the Indian stock market is quite shallow. Only a few stocks (top 5 in Nifty or Sensex) have a high market capitalization and good impact cost (a measure of liquidity). Slide down below and things change fast (notice how quickly the weight drops within the Nifty 50 top 10 – stock 9 and 10 of the Nifty 50 have a lower weight than corresponding stocks in NN50).

So this means, guaranteed higher volatility (although it has reduced recently for NN50) and therefore guaranteed uncertainty in returns. Also, future NN50 returns are unlikely to be as high as those seen in the past due to lower volatility perhaps due to higher market participation. Either we accept this and exit or we accept this and invest.

This is what we recommend:

  1. If NN50 performance is worrying you, reduce its exposure or exit completely. Peace of mind is more important than XIRR.
  2. If you are willing to keep the faith with NN50, make it conditional. Ask yourself how much more are you willing to wait for it beat the Nifty? Seven years? Eight years? Ten years? Can your financial need afford this wait? Then Wait. Not all our investing calls would come good. There is no harm in changing lanes if things do not pan out as intended. Of course, NN50 could start performing better after we exit but such is life. There is no room for regret either in investing. We can only decide with the data available in real-time.

In summary, the current drought in NN50 performance is not new. We have seen similar stretches in the past. The only problem is, unlike in the past, we do not know when the recovery will come along. Waiting will have consequences. Exiting will have consequences. Which of these is more acceptable to you is the question.

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