The Execs and Cons of Equal Weight Indices

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

On this publish, allow us to take a look at a number of the good and not-so-good factors about equal weight indices. We’ll see how equal weight indices have carried out over the past 2 a long time in comparison with the market-cap primarily based indices.

Sharing briefly initially. Will talk about the nuances later.

Cap-Based mostly 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.

As an example, Nifty 50 Equal Weight index, weights of all of the shares within the index can 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. This may 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 prime shares can supercharge the index returns. Equally, the under-performance of some prime shares could make the complete index endure. This won’t occur in an equal weighted index.

Equal weight indices are more likely to be extra diversified, as a single inventory (or a couple of shares) will be unable to hijack the complete index. EW indices are more likely to have a greater diversified trade publicity.

Contemplate 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 prime shares is kind of excessive.

In Nifty 50 Equal weight, the weightage of inventory is near 2%. Will get again to actual 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 greater, it’s cheap to besides that the inventory can even be liquid i.e., you might be able to purchase and promote the inventory at a low affect value. Bid and ask costs could also be nearer. The liquidity in a inventory is vital 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 should purchase in proportion of their market cap. As an 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.

Contemplate Nifty 500 Equal Weighted index.

Would the inventory which ranks between 450 and 500 when it comes to 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 relies on 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 all in favour of an equal weighted index, do regulate the monitoring distinction.

#3 Publicity

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

Offers you publicity to virtually the complete 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. Prime 500 shares.

Whereas the shares are the identical, the allocation to the big, 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 are usually not 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 healthier 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.

Regardless of how indices have carried out up to now, there can be instances sooner or later when Nifty 500 will outperform. And there can be instances 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 big caps are outperforming, Nifty 500 will possible beat Nifty 500-EW.

And earlier than you put money into any product, you will need to understand how your cash should be invested.

How have Equal Weight Indices fared?

All this data is ok, 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, 2005, till August 31, 2024.

I’ve used Value index knowledge (PRI) for comparability. And never Complete Returns index. Please perceive you can’t put money into the index fund straight. You need to make investments by means of index funds or ETFs. Therefore, whereas evaluating, you will need to regulate the expense ratio and the monitoring distinction.

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

Since we’re talking about equal weight indices, you must see if the outperformance of equal weight indices comes when smaller shares have carried out properly. This may possible be the case as properly. As an example, a technique 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 proper technique 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 depart 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 contains 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 possibly can discover that Nifty 500 Equal Weight outperforms when the midcap and small cap indices have carried out properly. You possibly can examine this from calendar yr returns too. Alongside anticipated traces.

Must you put money into Equal Weight indices?

There isn’t a black and white reply to this query. Will depend on your choice and the way you wish to use these in your portfolio. As an example, an investor can mix Nifty 500 and Nifty 500 Equal Weight in a particular ratio portfolio to get the specified allocation to giant, midcap, and small cap funds within the portfolio.

For those who plan to put money into an equal-weight index fund, you will need to take into account the next points.

1. Don’t simply go by fancy presentation by AMCs. Perceive type of publicity the EW index fund affords.
2. Contemplate 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 put money into the index. You put money into index funds and ETFs. Contemplate expense ratio and monitoring distinction
4. Assess if the equal weight index fund provides ample worth to warrant one other fund within the portfolio.

Passive investing is selecting up in India. Therefore, count on AMCs to launch new concepts frequently, however you can’t 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 publish is for training goal alone and is NOT funding recommendation. This isn’t a suggestion to take a position or NOT put money into any product. The securities, devices, or indices quoted are for illustration solely and are usually not recommendatory. My views could also be biased, and I’ll select to not give attention to points that you just take into account vital. Your monetary objectives could also be totally different. You could have a special threat profile. You could be in a special life stage than I’m in. Therefore, you will need to NOT base your funding choices primarily based on my writings. There isn’t a one-size-fits-all answer in investments. What could also be a great funding for sure traders might NOT be good for others. And vice versa. Subsequently, learn and perceive the product phrases and circumstances and take into account your threat profile, necessities, and suitability earlier than investing in any funding product or following an funding strategy.