The Professionals and Cons of Equal Weight Indices

Equal weight indices are in vogue. You have to have observed contemporary index fund launches from numerous AMCs.

On this submit, allow us to have a look at a few of the good and not-so-good factors about equal weight indices. We are going to see how equal weight indices have carried out during the last 2 many years in comparison with the market-cap primarily based indices.

Sharing briefly firstly. Will focus on the nuances later.

Cap-Primarily based Indices Vs Equal Weighted Indices

In a market cap-based index (Nifty 50, Sensex, Nifty Subsequent 50, Nifty Midcap 150), a inventory with a better free-float market cap will get a better weightage within the index.

In an equal weight index, all of the shares have the identical weightage. Sure, the weights might change primarily based on the efficiency of constituent shares however are rebalanced to the identical weight on the rebalancing date.

For example, Nifty 50 Equal Weight index, weights of all of the shares within the index shall be rebalanced to 2% on the date of rebalance. The index is rebalanced semi-annually on the final working day of March and September.

With a market-cap primarily based index, the weightage of a inventory will improve (lower) with good (unhealthy) efficiency of the inventory. The allocation to rising shares will improve. It will occur in an EW index too, however the portfolio will reset to equal weight on the portfolio rebalancing date.

In an EW index, the cash would transfer from better-performing inventory to an underperforming inventory on the rebalancing date. This makes extra of a “Worth” play. Market-cap primarily based indices let the shares experience the “momentum”.

#1 Diversification

With a market-cap primarily based index, outperformance in a single or few high shares can supercharge the index returns. Equally, the under-performance of some high shares could make your entire index undergo. This won’t occur in an equal weighted index.

Equal weight indices are prone to be extra diversified, as a single inventory (or a couple of shares) won’t be able to hijack your entire index. EW indices are prone to have a greater diversified trade publicity.

Take into account trade and constituent-wise break up for Nifty 50.

Supply: Factsheets for respective indices on NiftyIndices.com. Information as on July 31, 2024

Now for Nifty 50-Equal Weight.

Within the cap-based Nifty 50 Index, the weightage of high shares is sort of excessive.

In Nifty 50 Equal weight, the weightage of inventory is near 2%. Will get again to precise 2% on the rebalancing date.

Therefore, on the diversification entrance, equal weight indices appear to attain over cap-based indices.

#2 Liquidity

When a inventory’s free-float market cap is larger, it’s cheap to besides that the inventory may also be liquid i.e., you might be able to purchase and promote the inventory at a low influence value. Bid and ask costs could also be nearer. The liquidity in a inventory is necessary as a result of the fund supervisor wants to purchase and promote inventory to handle purchases and redemptions.

Whereas in a cap-based index, the fund supervisor must purchase in proportion of their market cap. For example, if a fund supervisor should deploy Rs 10 crores in a Nifty index fund, he/she should make investments say about 1.1 crore every in HDFC Financial institution, 94 lacs in Reliance Industries and so forth. These quantities are primarily based on weights as on July 31, 2024.

Nevertheless, in an equal-weight index, the fund supervisor should purchase all of the shares for a similar quantity. 20 lacs in every of the shares in Nifty 50.

Now, this liquidity will not be an issue for Nifty 50 Equal Weight. However there are different equal weight indices as properly.

Take into account Nifty 500 Equal Weighted index.

Would the inventory which ranks between 450 and 500 by way of market cap have the identical liquidity and volumes as Reliance Industries, HDFC Financial institution, or Infosys? However the fund supervisor should purchase/promote all these shares for a similar quantity. It’s an equal-weighted index. Would that improve monitoring distinction?

Market cap-based indices maintain these points by design. The allocation depends upon the free float market cap. A much bigger inventory will get a better allocation. And a small inventory will get a decrease allocation. No such luxurious in equal weight indices.

Therefore, in case you are involved in an equal weighted index, do keep watch over the monitoring distinction.

#3 Publicity

What does a Nifty 500 index fund offer you publicity too?

Provides you publicity to nearly your entire market spectrum. Massive cap, midcap, and small cap. Right here is the classification of shares as per SEBI definition.

Massive cap: 1-100^th inventory by market cap

Midcap;101^st-250^th inventory by market cap

Small cap: 251^st-500^th inventory by market cap

What doesn’t a Nifty 500 Equal Weight index offer you publicity to?

To the identical set of shares. High 500 shares.

Whereas the shares are the identical, the allocation to the massive, midcap, and small cap indices is drastically totally different.

Nifty 500: Massive cap: ~72%, Midcap: ~17%, Small cap: ~10%

Nifty 500 Equal Weight: Massive cap: 20%, Midcap: 30%, Small cap: 50%

Information as on July 31, 2024. Supply: Nippon AMC presentation

Disclaimer: The securities proven above aren’t recommendatory.

Nifty 500 appears extra like a big cap or a multicap fund.

Nifty 500 Equal Weight is extra like a mid and small cap fund.

I’m not implying that the Nifty 500 index is best than Nifty 500 Equal Weight index or vice versa. Merely saying that these are 2 massively totally different funds and offer you vastly totally different inventory market publicity.

No matter how indices have carried out previously, there shall be occasions sooner or later when Nifty 500 will outperform. And there shall be occasions when Nifty 500-EW will outperform Nifty 500. When there’s a broader market rally and mid and small cap shares are outperforming, you’ll be able to count on Nifty 500-EW to carry out higher.

When the massive caps are outperforming, Nifty 500 will seemingly beat Nifty 500-EW.

And earlier than you spend money on any product, you should understand how your cash have to be invested.

How have Equal Weight Indices fared?

All this data is okay, however how these EW indices have fared in comparison with well-liked market-cap primarily based indices.

I’ve picked up outstanding equal weight and market cap-based indices for the comparability.

1. Nifty 50
2. Nifty 50 Equal Weight
3. Nifty 100
4. Nifty 100 Equal Weight
5. Nifty Subsequent 50
6. Nifty Midcap 150
7. Nifty Smallcap 250
8. Nifty 500
9. Nifty 500 Equal Weight

I’ve used month-end knowledge from April 1, 2004, till August 31, 2024.

I’ve used Value index knowledge (PRI) for comparability. And never Complete Returns index. Please perceive you can not spend money on the index fund immediately. You have to make investments by means of index funds or ETFs. Therefore, whereas evaluating, you should keep watch over the expense ratio and the monitoring distinction.

Whereas evaluating any funding in your portfolio, you should additionally attempt to see when these merchandise have outperformed.

Since we’re talking about equal weight indices, you want to see if the outperformance of equal weight indices comes when smaller shares have completed properly. It will seemingly be the case as properly. For example, a option to view the efficiency of Nifty 50 and Nifty 50 Equal Weight is to evaluate together with the efficiency of Nifty Subsequent 50 index. I do know this isn’t the right option to consider efficiency. The rationale I picked Nifty Subsequent 50 is as a result of it has shares simply outdoors of Nifty 50 and smaller than Nifty 50 shares.

I’ll go away this knowledge to your interpretation.

Nifty 50 vs Nifty 50 Equal Weight

As mentioned above, bringing in Nifty Subsequent 50 for comparability too.

Nifty 100 vs Nifty 100 Equal Weight

Since Nifty 100 index includes of shares in Nifty 50 and Nifty Subsequent 50 index fund, I’ve added these funds for comparability too.

Nifty 500 vs Nifty 500 Equal Weight

Since Nifty 500 Equal weight has 30% midcap and 50% small cap shares, I’ve added these indices too for comparability.

You may discover that Nifty 500 Equal Weight outperforms when the midcap and small cap indices have completed properly. You may test this from calendar 12 months returns too. Alongside anticipated traces.

Do you have to spend money on Equal Weight indices?

There isn’t a black and white reply to this query. Is determined by your desire and the way you need to use these in your portfolio. For example, an investor can mix Nifty 500 and Nifty 500 Equal Weight in a selected ratio portfolio to get the specified allocation to giant, midcap, and small cap funds within the portfolio.

Should you plan to spend money on an equal-weight index fund, you should think about the next features.

1. Don’t simply go by fancy presentation by AMCs. Perceive type of publicity the EW index fund presents.
2. Take into account previous efficiency. Whereas previous efficiency shouldn’t be an indicator of future efficiency, attempt to see if you will get the expertise of EW index fund by mixing 2 cap-based indices. By expertise, I imply each returns and volatility.
3. You don’t spend money on the index. You spend money on index funds and ETFs. Take into account expense ratio and monitoring distinction
4. Assess if the equal weight index fund provides enough worth to warrant one other fund within the portfolio.

Passive investing is selecting up in India. Therefore, count on AMCs to launch new concepts regularly, however you can not make investments in all places.

Have you ever invested in Equal Weight indices? If sure, which one and why? Do let me know within the feedback part.

Disclaimer: Registration granted by SEBI, membership of BASL, and certification from NISM by no means assure efficiency of the middleman or present any assurance of returns to traders. Funding in securities market is topic to market dangers. Learn all of the associated paperwork fastidiously earlier than investing.

This submit is for schooling function alone and is NOT funding recommendation. This isn’t a suggestion to speculate or NOT spend money on any product. The securities, devices, or indices quoted are for illustration solely and aren’t recommendatory. My views could also be biased, and I’ll select to not give attention to features that you simply think about necessary. Your monetary objectives could also be totally different. You’ll have a unique danger profile. You might be in a unique life stage than I’m in. Therefore, you should NOT base your funding selections primarily based on my writings. There isn’t a one-size-fits-all answer in investments. What could also be a superb funding for sure traders might NOT be good for others. And vice versa. Subsequently, learn and perceive the product phrases and circumstances and think about your danger profile, necessities, and suitability earlier than investing in any funding product or following an funding method.