Last Updated on December 29, 2021 at 5:38 pm
Readers may recall that the Nifty/Sensex moved up since Feb 2018 (until the crash this year) while the rest of the market moved down. We had reported that this market imbalance/inhomogeneity lead to an all-time high return difference between Nifty 50 vs Nifty 50 Equal-weight indices in Dec 2019 and also pointed out that Market crash destroys two-year imbalance among Index stocks. Has this imbalance returned over the last month? If it continues, is it bad news for both active and passive equity mutual funds!
The imbalance between Nifty 50 and Nifty 50 Equal-weight movements had started to decrease months before the market crash in March but seems to have returned over the last month.
This can be best appreciated by looking at the two-year return difference between the Nifty 50 and the Nifty Next 50. The Nifty 50 is a market capitalization-weighted index. Since the distribution of market cap is not uniform, just a few stocks dominate the Nifty 50 index. Sensex, BSE 100, 200, Nifty Next 50, NIfty 100, 200 500 are all market-cap-weighted indices.
Join 32,000+ readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! (Link takes you to our email sign-up form)
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
The top three stocks in the NIfty (June 2020) – Reliance Industries, HDFC Bank and HDFC – make up 30% of the 50 stock index! The top 5 stocks, 41.55%. The top ten stocks 62.69%. If these ten stocks move up, the Nifty will move up a bit even if the rest of the 40 stocks fall. This is even more dramatic in the Nifty 100. Just ten stocks account for 53.57% of the weight and only 11 stocks have a weight above 2% as seen below.
The Nifty 50 Equal Weight index has approximately equal weight for all stocks (there is a Nifty 100 Equal Weight index as well). Shown below is the T]two-year rolling return difference Nifty 50 Equal-Weight TRI and Nifty 50 TRI from June 1999.
Notice how the Nifty 50 Equal-weight return minus NIfty 50 return fell to an all-time low just before the market crash. The crash corrected this, but if we take a closer look at the same graph, it is slipping back over the last month (white circle in the image below).
Notice how the return difference dropped below zero (N50 return > N50EW return) from Feb 2018 onwards. If we look at the full return difference graph, N50EW-N50 seems to be a reasonable indicator of market valuation. As the price moves up, this return difference seems to move down. Please note: I make no claim that this is a technically sound indicator, just making an interesting, almost uncanny observation.
I believe the reason this imbalance (N50 return > N50EW return) is the reason for the sudden interest in index funds*; is the reason why active fund managers visibly failed to beat the Nifty. When the imbalance is removed, the visible outperformance returns as seen in mid-May: after the market crash, 80% of active large cap funds outperform Nifty, Nifty 100.
An active fund manager who is not heavy on stocks that drive the NIfty/Sensex is likely to underperform. If they follow the NIfty or Sensex then we would be paying more for passive investing!
The stress on “visibility” is to denote that this is a casual observation. Even before this imbalance not more than 50% of funds in a category beat the index: Poor performance of active mutual funds: Is this a recent development? That said, this imbalance is bad news for index investors as well. Their returns hinge on just a handful of stocks and that cannot be good news. Active MFs have more money invested in these stocks than passive funds so there is need to worry about an “index bubble”
* An index investor choosing an index because it is making better returns than an active fund is doing so for the wrong reasons: Are Indian Investors ready to choose Index mutual funds or ETFs?. Also see: How to select an index fund (do you really need one?)
The last one and three month returns for the top ten Nifty stocks is shown below.
| Company | Weight in Nifty 50 | 1-Month Return | 3-Month Return(%) |
| Reliance Industries Ltd. | 12.45% | 16.06 | 56.54 |
| HDFC Bank Ltd. | 10.65% | 7.16 | 17.62 |
| Housing Development Finance Corpn. Ltd. | 7% | -0.13 | 8.14 |
| Infosys Ltd. | 3.21% | 20.07 | 30.37 |
| ICICI Bank Ltd. | 5% | 0.46 | 4.58 |
| Tata Consultancy Services Ltd. | 5.04% | 9.53 | 26.98 |
| Kotak Mahindra Bank Ltd. | 4.59% | 0.8 | 3.13 |
| Hindustan Unilever Ltd. | 4% | 7.97 | -3.04 |
| ITC Ltd. | 3.92% | 2.48 | 9.42 |
| Bharti Airtel Ltd. | 3.10% | 0.62 | 10.04 |
Reliance Industries Ltd. contributed to 45% of the Nifty’s last one month return and 55% of the last three month’s return. HDFC Bank 17% and 14% respectively over corresponding durations.
This is normal in a market-cap-weighted index but when the rest of the stocks do not move up as much then the imbalance is striking. We are slowly beginning to learn how the lockdown impacted businesses big and small. This will eventually slow down this “rally” if not bring the market crashing down again. Will this homogenise the market or make the imbalance worse? Only time will tell.
What should an investor do? Nothing, as there is not much one, can do. Index investors must be prepared for a phase (however brief) where they see ‘some’ large cap funds beat the index. This imbalance could be one reason why funds like Quantum Long Term Equity and ICICI Value Discovery are struggling over the last couple of years.
Does it make sense for investors to give these fund managers a bit more time or will this imbalance never correct? It becomes a tussle over the heart vs mind. If you recognise that buying the index is better than trying to be invested in the best/good funds then you can switch.
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 7000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 2,500 investors and advisors use this!
Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter using the form below.
- Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Join 32,000+ readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! (Link takes you to our email sign-up form)
About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our YouTube Videos
- Posts feed via Feedburner.
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.Your Ultimate Guide to Travel
This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)