Invest in equal-weight index to reduce concentration risk: Analysts

Begin with a 50:50 allocation to Nifty50 & Nifty50 Equal Weight index fund

In 2019, the Indian equity market witnessed a narrow rally, led by the so-called HRITHIK stocks (HDFC, Reliance Industries, Infosys, TCS, HDFC Bank, ICICI Bank, and Kotak Mahindra Bank). At that time, the Nifty 50 Equal Weight Index underperformed the Nifty50.

However, the rally that ensued after the collapse of March 2020 was more broad-based. During this period, the Nifty 50 Equal Weight Index beat the Nifty50 handily (see table).

While Aditya Birla Sun Life Mutual Fund (MF) and DSP MF already have index funds based on the Nifty50 Equal Weight Index, HDFC’s new fund offer for a similar fund will begin on August 4 and close on August 13.

How is it different?

The Nifty50 Equal Weight Index owns all the constituents of the Nifty50 (large-cap blue chips) but with a twist. 

Instead of assigning weights to each stock based on its market capitalisation, this index gives equal weight to all the stocks — 2 per cent each. Rebalancing happens quarterly. In the Nifty50, the top five stocks account for about 40 per cent of the index, while in the equal weight index, they account for only 10 per cent. 

Does this work?

If you look at past returns, the picture is mixed. The Nifty50 Equal Weight Index has beaten the Nifty50 in 2020 and also year-to-date. It also outperformed in 2016. However, it underperformed in 2017, 2018, and 2019.  

On a trailing returns basis, it has outperformed over the past year. Both the indices have provided similar returns over the three-year period. But the Nifty50 has outperformed over the five-, seven- and 10-year periods.   

According to Anil Ghelani, head — passive investments and products, DSP Investment Managers, “In Nifty50 Equal Weight, stocks that form the tail of the index — the bottom 10 stocks — have about 20 per cent weight as opposed to just 6 per cent in the Nifty50. A broad-based rally allows this tail to outperform the index heavyweights, and at a faster pace.”

Adds Gautam Duggad, head of research, Motilal Oswal Institutional Equities: “More sectors participated in the earnings recovery, apart from the usual private financials, consumer and IT sector. Metals, pharmaceuticals, and cement saw sharp earnings growth in FY21.” 

Ghelani expects the Nifty50 Equal Weight Index’s outperformance to continue for some time. “This index is overweight on some of the top-performing sectors, like metals and healthcare, vis-a-vis the Nifty50. If the broad-based rally continues, its outperformance will continue,” he says. On the other hand, if sectors such as financials and IT, which have more weighting in the Nifty50 outperform, then it may do better.

The government’s initiatives like the production-linked incentive (PLI) schemes, its focus on infrastructure, and low interest rates may boost the earnings of many companies. Duggad, too, expects broad-based earnings growth to continue in FY22 and FY23.

Should you invest?

Financial advisors say investors, including new and risk-averse ones, may invest in a Nifty50 Equal Weight Index Fund. 

“With these funds, you avoid concentration risk, which is generally the case with the major indices,” says Viral Bhatt, founder, Money Mantra. 

He adds that higher diversification implies lower risk and auto rebalancing ensures investors gain from buying low and selling high. He suggests that investors begin with a 50:50 allocation to a Nifty50 index fund and a Nifty 50 equal weight index fund for their large-cap allocation.