The Execs and Cons of Equal Weight Indices

Equal weight indices are in vogue. You will need to have observed recent index fund launches from varied 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 are going to see how equal weight indices have carried out over the past 2 many years in comparison with the market-cap primarily based indices.

Sharing briefly in the beginning. Will focus on 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 the next free-float market cap will get the next weightage within the index.

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

As an illustration, Nifty 50 Equal Weight index, weights of all of the shares within the index will probably 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 enhance (lower) with good (unhealthy) efficiency of the inventory. The allocation to rising shares will enhance. 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 journey 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 your complete 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 complete 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. Knowledge 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 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 affordable to besides that the inventory can even be liquid i.e., you could possibly purchase and promote the inventory at a low influence value. Bid and ask costs could also be nearer. The liquidity in a inventory is essential 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. As an illustration, 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.

Nonetheless, 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 might not be an issue for Nifty 50 Equal Weight. However there are different equal weight indices as nicely.

Take into account 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 enhance monitoring distinction?

Market cap-based indices deal with these points by design. The allocation will depend on the free float market cap. An even bigger inventory will get the next allocation. And a small inventory will get a decrease allocation. No such luxurious in equal weight indices.

Therefore, if you’re considering an equal weighted index, do control the monitoring distinction.

#3 Publicity

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

Offers you publicity to nearly your 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. High 500 shares.

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

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

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

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

Disclaimer: The securities proven above should 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 vastly completely different funds and offer you vastly completely different inventory market publicity.

No matter how indices have carried out up to now, there will probably be occasions sooner or later when Nifty 500 will outperform. And there will probably 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 possibly can anticipate Nifty 500-EW to carry out higher.

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

And earlier than you spend money on any product, you will need to know the way your cash should be invested.

How have Equal Weight Indices fared?

All this data is okay, however how these EW indices have fared in comparison with standard 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 Whole Returns index. Please perceive you can not spend money on the index fund straight. You will need to make investments by means of index funds or ETFs. Therefore, whereas evaluating, you will need to control the expense ratio and the monitoring distinction.

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

Since we’re talking about equal weight indices, it is advisable see if the outperformance of equal weight indices comes when smaller shares have performed nicely. This may seemingly be the case as nicely. As an illustration, a approach 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 approach to consider efficiency. The explanation 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 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’ll be able to discover that Nifty 500 Equal Weight outperforms when the midcap and small cap indices have performed nicely. You’ll be able to examine this from calendar 12 months returns too. Alongside anticipated traces.

Do you have to spend money on Equal Weight indices?

There is no such thing as a black and white reply to this query. Will depend on your desire and the way you wish to use these in your portfolio. As an illustration, an investor can mix Nifty 500 and Nifty 500 Equal Weight in a particular ratio portfolio to get the specified allocation to massive, midcap, and small cap funds within the portfolio.

For those who plan to spend money on an equal-weight index fund, you will need to think about the next elements.

1. Don’t simply go by fancy presentation by AMCs. Perceive type of publicity the EW index fund gives.
2. Take into account previous efficiency. Whereas previous efficiency is just not an indicator of future efficiency, attempt to see if you may 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 ample worth to warrant one other fund within the portfolio.

Passive investing is choosing up in India. Therefore, anticipate AMCs to launch new concepts frequently, however you can not make investments in every single place.

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 on no account 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 schooling goal alone and is NOT funding recommendation. This isn’t a advice to speculate or NOT spend money on any product. The securities, devices, or indices quoted are for illustration solely and should not recommendatory. My views could also be biased, and I could select to not concentrate on elements that you just think about essential. Your monetary objectives could also be completely different. You’ll have a special danger profile. It’s possible you’ll be in a special life stage than I’m in. Therefore, you will need to NOT base your funding selections primarily based on my writings. There is no such thing as a one-size-fits-all answer in investments. What could also be a great funding for sure traders could NOT be good for others. And vice versa. Due to this fact, 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.