Evaluating the Nifty Next 50 as an Index Fund

Published: August 15, 2016 at 11:13 am

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Are you worried the high expense ratios of active mutual funds? Are you looking for an index fund that has performed reasonably well with low expenses? Then you can consider a Nifty Next 50 index fund instead of active funds in the multi-cap category.

Why? As pointed out in a series of posts on the Nifty Strategy Indices as Mutual Fund Benchmarks, the Nifty Next 50 or formerly the Nifty Junior which consists of stocks with top 50-100 market capitalization has a good record in the multi-cap category.

Nifty Next 50 Index fund: 5-year Returns

Nifty next 50 index fund
The red bar corresponds to ICICI Pru Nify Next 50 Index fund

Consider the return-rank of ICICI Pru Nifty Next 50 fund:

21st out of 64 funds over 5 years. This considers the regular and direct plans as independent funds. (In a sense this is double-counting)

47/138 over 3 years and 1 year.

This performance at a fraction of the expense ratio of most funds in the category. The y-axis in the above graph represents the current expense ratio plotted against the 5-year returns. Notice where the red bar is.

I can spot only two index funds based on Nifty Next 50 – one from  ICICI, one from IDBI and an ETF from SBI.

As mentioned in the above post, this is an impressive performance.

Wait a minute!

The last 5 years has not witnessed a robust bull run like in the 2000s. What if we extend the analysis further back?

I used my mutual fund return listings tool to check returns for the last 9 years. Here only regular plans are considered.

Nifty-next-50-index-fund-1

I think it is reasonable to conclude that about 70% of active funds have beat the Nifty Next 50. However, the number of multi-cap funds have doubled in the last 9 years. So this 70% margin is likely to fall in future.

Update: Please see my response to Shan’s comment below about GS Junior Bees has performed.

Choosing an index fund boils down to how much we expect the outperformance to fall in the long-term.

Pros of Index Investing

In the large-cap category, most active funds beat Sensex or Nifty index funds (how is a matter of debate!!). Over the last 10 years, only 3 active large cap funds have underperformed wrt index funds and these are duds no one would touch. Over the last 5 years, the corresponding number is just 5.

In the primarily large-cap plus mid-cap category (multi-cap), the NIfty Next 50 Index funds have provided good returns considering the extremely low expenses.

No need to worry about fund management changes.

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Pretty much a turnkey mutual fund solutions to beat inflation (with portfolio management)

The Next 50 index has a nice large cap tilt with 15-20% exposure to mid-caps. This makes it a minimalist portfolio without the dangers of small and micro caps.

Cons of Index Investing

Active management is not about just for beating the index. It is also for lowering risk*. An index fund has a risk equal to that of its underlying index. In the case of a sustained sideways market, an index fund can not only be stressful to hold, but also may be detrimental for our goal.

* I shall give an interesting example of this point tomorrow.

Index investing requires tremendous maturity. One will have to recognise that selecting the right equity mutual fund scheme is not possible and not worry about the funds that have (or will) beat the Nifty Next 50 index funds.

Trivia

Over the last 5 years,

the ICICI Pru Nifty Next 50 Index Fund has beat (not by much) Quantum Equity Fund of Funds. This is a professionally managed basket of direct plan active funds.

beat HDFC Equity by almost 3%!

The ICICI Pru Nifty Next 50 Index Fund direct plan has an expense ratio of only 0.29% as against 0.84% for  the regular plan! The regular fund has a 3-year return rank of 47/138 and the direct plan 39/138!

To be fair, the multi-cap category as defined by Value Research is quite varied. It has a CNX 500 index fund, a fund of fund, at least two funds that invest in international equity (PPFAS,Templeton India Equity Income). They may simply not consider the Nifty Next 50 as a target to beat.

Still, from an investor’s view point, the Nifty Next 50 is a very good alternative in terms of pure return per unit expense ratio. That said, return is a point to point perspective. The risk or the stress associated with index investing  is often not considered. I would like to think active management which offers better risk-adjusted returns for higher fees is still something to consider.

Note: I am not suggesting that we abandon active multi-cap funds in favour of NIfty Next 50. Just saying that such an index fund could be a good choice of investors who are repulsed by high expenses and believe that the outperformance margin will come down in future.

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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.
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12 Comments

  1. Thanks for the valuable analysis… definitely a good option for people who are inclined to index based fund …also pros & cons of index based funds are well explained.

    You said “In the large-cap category, most active funds beat Sensex or Nifty index funds (how is a matter of debate!!).” It will be nice if you can throw some light on “how is a matter of debate!!”. Till date, my idea is that indulging in trading based is their one way when market moves side-way.

    1. There are at least two way to beat the index: use different weights or buy stocks from outside the index. Many large cap funds hold good amt of mid-caps. It can be argued that the alpha came via these stocks.

  2. 🙂 Pattu after many years you have finally come over to see my point of view.

    BTW you’re missing out on the grand-daddy of Next 50 fund – Juniorbees (launched in 2003) – I held it for close to a decade and handily beat the index, WITHOUT the fund manager risk!

    But the other thing folks will hopefully come to realize is that nifty next 50 can be held for a long time (heck even passed along for generations) without really being bothered. Fill it, shut it, forget it. Maybe your grandson/granddaughter will use it! Put your energy where it makes a big dent today. Picking the ‘best’ fund manager and then rotating funds based on who’s doing well …. wow, trust me this is not for the common man and the fund manager risk is enormous over long periods of time. And all for what, a few basis points of ephemeral ‘alpha’? Lol. Just as Donald Knuth (perhaps the greatest computer scientist of all time) said: ‘premature optimisation is the root of all evil’

    1. Yes a bad miss to have forgotten about the GS fund.Over a 10Y period only 5 funds managed to beat it and over 5Y only 14. But how did you manage to beat the index by using an index fund?!

  3. 🙂 no I mean nifty jr beat nifty 50 (the ‘index’ in usual parlance). And I agree that while there’s no reason that this would always be true, Bogle himself has analyzed and concluded that midcap index funds beat largecap index funds over long periods of time

  4. Pattu,
    Super subject to broach on in midst of of all the frenzy ! .. I think that “active” funds will still beat index funds in india , since by definition , the index is built with companies that have already “made it” in the industry and market. Hence the GS Junior Bees is beating the index , and as per your sheets it has a super capture ratio also .. so a comparison of nifty 50 and jr is perhaps required to see which might be a better index to follow ?

    1. index funds or etfs cannot have a capture ratio. By definition they track the index. It is not a question of Nifty or Nifty Jr as there is no overlap bet indices. Both are needed for diversification.

  5. I am a big fan of Index funds..However there are very few index funds available from Fund House.. Most are either Nifty 50 else Sensex & Nifty Next 50 available from 2 Fund house as mentioned in your article…Why is it so?

  6. Dear Professor,
    I have read again this article and came to know that index fund expense ratio also changing? How and why the expenses changes for index funds ? That also for Direct Funds? Sounds Ahhh ?

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