Last Updated on August 22, 2022 at 11:15 pm
Frustration about varying active fund management and the need to shift funds has led to more and more investors considering index investment options. Although still a minority, it is definitely a healthy trend towards simpler portfolio management. A combination of Nifty + Nifty Next 50 index funds is a neat way to get large cap and mid cap exposure, but what is the right mix? An analysis.
Although SEBI has defined the top 100 stocks by free-float market cap as the “large cap universe”, we have repeatedly pointed out that Nifty Next 50 is NOT a large cap index! This is because of the large impact costs down the NIfty 100 ladder. See Warning! Even large cap stocks are not liquid enough! Can you handle this?
While we now have a Nifty 100 index fund – Axis Nifty 100 Index Fund Impressive AUM but is it expensive? – this is equivalent to adding 10%-20% of Nifty Next 50 to Nifty 50. See: Combine Nifty & Nifty Next 50 funds to create large, mid cap index portfolios
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Those who wish to add more of Nifty Next 50 or like the freedom to freely rebalance between the top and bottom halves of the Nifty 100 may prefer a two-fund combination.
As pointed out in Benjamin Graham’s 50% Stocks 50% Bonds strategy analysis, there cannot be an optimal mix when you add two asset classes. It is like adding red paint with white paint. The shade of desirable pink is personal.
Also, we have little history to study. A combined SIP in both indices can only be studied from Dec 2002. This just means 90 10-year rolling return data points.
If we compare a Nifty-only portfolio and a Nifty Next 50-only portfolio, notice that the NN50 has sometimes outperformed significantly, but that drops down to NIfty levels. It is amusing that a highly volatile index like NN50 has outperformed the N50 during the Feb-Mar 2020 market crash! That is an indication of how overvalued the Nifty was: Market crash destroys two-year imbalance among Index stocks
This should not be used as an indicator to go overboard on NN50 allocation. The portfolio drawdown is not shown here and a simple inspection of the NN50 price movement is enough to indicate that it can fall big.
It should be clear from the above date that gradually adding NN50 to N50 would only increase the returns for the time period studied (not indicative of future performance)
This is the relative volatility of 100% NN50 and 50% NN50 + 50% N50 portfolios compared with a Nifty-only portfolio. The monthly volatility over a 10-year period is measured.
The 100% NN50 portfolio has been almost 25% more volatile than a 100% N50 portfolio. Investing while adding NN50 should expect at least this excess volatility and can suitably weight it with their own exposure.
Please note that these portfolios have been rebalanced annually and associated taxes and loads are not factored in. Systematic rebalancing is crucial to reduce risk.