Q. I am a retired civil servant, my wife is also retired. Since the time we retired, we have been investing in index mutual funds tracking Nifty50 and Sensex. Many of our acquaintances have been suggesting us to invest in index mutual funds tracking Nifty50 Equal Weight Index. Can you please elaborate on the differences between Nifty50 and Nifty50 Equal Weight Index, their relative performances and the pros and cons of investing in mutual funds tracking Nifty50 Equal Weight Index?
V. Karunakaran, Kottayam, Kerala
The Nifty Equal Weight Index offers a unique perspective on the Indian equity market, diverging from the traditional market capitalisation-weighted approach of its parent index, the Nifty50. Established with a base date of November 3, 1995, and a base value of 1000, the Nifty Equal Weight Index is composed of the same constituents as the Nifty50 but assigns an equal weight to each company, regardless of its market size.
This equal-weight methodology ensures that the index is not skewed towards larger companies, providing a more balanced representation of the market. It also means that the performance of smaller companies has a greater impact on the index compared to a market cap-weighted index, where larger companies dominate. The Nifty Equal Weight Index is rebalanced quarterly, ensuring that the weights remain equal over time.
Investors looking to mirror the performance of the Nifty Equal Weight Index have multiple options as several index mutual funds track the Nifty50 Equal Weight Index. The fund is rebalanced alongside the index, maintaining equal weight and thereby offering a distinct risk-return profile compared to traditional index funds.
The Nifty Equal Weight Index's performance can be a barometer for the broader market, particularly for investors interested in a more egalitarian approach to index investing. It challenges the notion that larger companies are always the most significant contributors to market movements, highlighting the potential of smaller companies within the Nifty50.
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Index constituents eligibility criterion
To be eligible for inclusion in the Nifty50 Equal Weight Index, a company must first be a constituent of the Nifty50 index. The selection criteria for the Nifty50 index are stringent, ensuring that only companies with high liquidity and a strong market presence are included. Here are the key eligibility criteria for a company to be considered for the Nifty50 Equal Weight Index:
Constituent of Nifty50: The company must be part of the Nifty50 index, which is determined based on free-float market capitalisation.
Equal weight assignment: Upon inclusion, each company is assigned an equal weight in the index. This is rebalanced quarterly, considering the closing prices of the index constituents five working days before the effective date of the changes.
Reconstitution: The index is reconstituted semi-annually along with the Nifty50. This ensures that the index remains up-to-date with the current market scenario and the companies that best represent the Indian economy.
Trading frequency and impact cost: A stock must have traded at an average impact cost of 0.50% or less during the last six months for at least 90% of the time for a basket size of ₹10 crores.
Listing history: The company should have a minimum listing history of 1 month as on the cutoff date for potential inclusion in the index.
Governance and rebalancing: The governance of the Nifty50 Equal Weight Index involves a three-tier structure, ensuring that the index remains transparent and reliable. The Index Advisory Committee and the Index Maintenance Sub-Committee play crucial roles in overseeing the index's methodology and rebalancing processes. Rebalancing of the index is a critical aspect that maintains its equal weight nature. It is conducted quarterly, and any ad-hoc rebalancing may be initiated if any constituent ceases to be part of the parent index due to suspension, delisting, or a scheme of arrangement.
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Performance, returns and comparison with Nifty50
As of June 28, 2024 the Nifty50 Equal Weight Index has given a one year return of 34.82%. It has given a 5 year compounded annual return of 19.10%. On the other hand as of June 28, 204 Nifty50 index has given a one year return of 25.13%. It has given a 5 year compounded annual return of 15.29%.
Please see below the top five index mutual funds (direct schemes) tracking Nifty Next 50 Equal Weight Index basis their one and two year performance.
| Name | Expense Ratio | 1 Year Return (CAGR) | 3 Year Return (CAGR) |
| HDFC NIFTY50 Equal Weight Index Fund Direct Plan | 0.4% | 36.02% | N.A. |
| DSP Nifty 50 Equal Weight Index Fund Direct Plan | 0.4% | 36.01% | 20.83% |
| Aditya Birla Sun Life Nifty 50 Equal Weight Index Fund Direct Plan | 0.4% | 35.94% | 20.65% |
| ICICI Prudential Nifty50 Equal Weight Index Fund Direct Plan | 0.35% | 35.75% | N.A. |
| UTI NIFTY50 Equal Weight Index Fund Direct Plan | 0.59% | 35.61% | N.A. |
(Source: AMFI; data as of 1 July 2024)
Note: Past performance is not an indication of future returns.
Pros and cons of investing in index mutual funds tracking Nifty Next 50 Index
Investing in index mutual funds that track the Nifty50 Equal Weight Index can be an intriguing option for investors looking to diversify their portfolio. These funds offer a unique approach to index investing by allocating equal weight to each stock in the index, regardless of the company's market capitalisation. This method contrasts with traditional market-cap-weighted indices, where larger companies constitute a more significant portion of the index.
Pros
Diversification: Equal weight indices provide a more balanced exposure across all the stocks in the index, which can reduce the risk associated with any single stock's performance impacting the overall index significantly.
Performance potential: Historically, there have been periods where equal weight indices have outperformed market-cap-weighted indices, especially when smaller companies perform well relative to larger ones.
Simplicity: Investing in an index fund is a straightforward way to gain exposure to the stock market without the need to analyse individual stocks.
Lower costs: Index mutual funds typically have lower expense ratios compared to actively managed funds, making them a cost-effective investment option.
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Cons
Volatility: Equal weight indices can be more volatile than market-cap-weighted indices because they have a higher proportion of smaller companies, which are often more susceptible to market fluctuations.
Limited track record: Equal weight indices have a shorter historical performance record compared to their market-cap-weighted counterparts, which may make it harder for investors to predict future performance.
Nifty50 Index vs Nifty50 Equal Weight Index
The Nifty50 Index is a well-known benchmark Indian stock market index representing the weighted average of 50 of the largest Indian companies listed on the National Stock Exchange (NSE). It operates on a market capitalization-weighted method, meaning companies with higher market capitalisation have a more significant impact on the index's performance.
On the other hand, the Nifty50 Equal Weight Index provides an alternative by assigning an equal weight to each of the 50 stocks in the index, regardless of their market capitalisation. This means that each company contributes equally to the index's performance, which can lead to a different risk and return profile compared to the traditional Nifty50 Index.
Weightage of stocks: In a mutual fund tracking the Nifty50 Index, the weightage of each stock is proportional to its market capitalisation. Therefore, larger companies have a higher influence on the fund's performance. Conversely, in a mutual fund tracking the Nifty50 Equal Weight Index, all stocks have an equal weightage, which can potentially reduce the risk of concentration in a few large-cap stocks and provide a more balanced exposure across different sectors.
Performance:The performance of mutual funds tracking the Nifty50 Index closely follows the performance of the index itself, which is driven by the heavyweights within the index. In contrast, mutual funds tracking the Nifty50 Equal Weight Index may have a different performance trajectory due to the equal distribution of weightage among all stocks. This can sometimes lead to outperformance of the market cap-weighted index, especially when smaller companies perform well.
Expense ratio: Mutual funds tracking the Nifty50 Equal Weight Index often have a higher expense ratio than those tracking the Nifty50 Index. This is because equal weight index funds are considered more specialised and may incur higher costs for rebalancing and management.
Diversification: Mutual funds tracking the Nifty50 Equal Weight Index can offer better diversification as they allocate investments evenly across all 50 stocks. This can be beneficial during market volatility, as the impact of any single stock's performance is limited. However, this also means that the fund may miss out on the full benefit of a significant rally in a large-cap stock that would otherwise influence the Nifty50 Index more substantially.
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Taxation on index mutual funds tracking the Nifty50 Equal Weight Index
The taxation of mutual funds in India is dependent on the type of fund and the duration of the investment. For equity-oriented funds, which include funds tracking the Nifty50 Equal Weight Index, the following tax rules apply:
- Short-Term Capital Gains (STCG): If the units of the mutual fund are sold within one year from the date of investment, the gains are considered short-term and are taxed at a rate of 15%.
- Long-Term Capital Gains (LTCG): For units sold after one year from the date of investment, gains up to ₹1 lakh in a financial year are exempt from tax. Gains exceeding ₹1 lakh are taxed at a rate of 10%, without the benefit of indexation.
Tax planning is an integral part of investing. Understanding the nuances of taxation on mutual funds can help investors make informed decisions. With the right strategy, investing in mutual funds tracking the Nifty 50 Equal Weight Index can be a valuable addition to an investment portfolio, provided the tax implications are well understood and accounted for.
In conclusion, while investing in index mutual funds tracking the Nifty50 Equal Weight Index offers a unique investment strategy, it comes with its own set of advantages and challenges. Investors should consider their investment goals, risk tolerance, and the market environment when deciding whether this type of fund aligns with their portfolio strategy.
Choosing between mutual funds tracking the Nifty50 Index or the Nifty50 Equal Weight Index depends on your investment objectives, risk tolerance, and belief in the potential of a more concentrated portfolio versus a more diversified portfolio. It's essential to consider the differences in weightage, performance, expense ratio, tracking error, and diversification before making an investment decision.
Disclaimer: Investing in mutual funds involves risks, including potential loss of principal. Please consult with a financial advisor before making any investment decisions.
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