Explained: Is Nifty500 index a worthy bet for passive investors?

While the Nifty 50’s market-cap coverage has been shrinking over the years and it currently covers just over 50% of India’s total market-cap, Nifty 500 offers more than 90% coverage to India’s listed universe.

Nifty500 index is a broad-based index of the top 500 companies in India. These companies represent 96% value of the free float market. 

A fund based on this index will invest your money into those 500 companies in the same proportion as their weight on the index

In the last three years, the Nifty 500 index has delivered 25 per cent return on an annualised basis. The broader index has achieved a growth of 30 times compared to 23 times registered by Nifty 50, which covers only 51 per cent of the market cap. 

Investors who are bullish on the India growth story should not just look to invest in blue-chip companies but must have exposure to a wider market that includes both mid and small-cap stocks. 

Historically Nifty 500 has noted higher returns than Nifty 50 since its inception while at the same time it showcases lower volatility over the long-term. 

Over the medium to long term, the Nifty 500 Index has historically outperformed the Nifty 50 Index aided by a strong performance from the mid and smallcap segments. It is important to note that the Nifty 500 Index has exhibited less or similar risk (measured by standard deviation) despite the inclusion of midcap and smallcap stocks that are generally considered more volatile.  

The Nifty 500 also provides more stock-level diversification than Nifty50.

The index offers a blend of 75 per cent in largecap, 16 per cent in midcap and 9 per cent in smallcap. 

Moreover, currently, the passive funds tracking Nifty accounts for Rs 2.7 trillion, while that of Sensex is Rs 1.4 trillion. However, Nifty 500 is the most popular benchmark with 123 schemes with asset of Rs 5.8 trillion tracking it against 47 and 51 schemes benchmarked to Nifty and S&P BSE-500 with assets of Rs 2.79 trillion and Rs 1.69-trillion, respectively.

Nifty 500 vs Nifty 50 and Sensex

 

"Compared to the Nifty 50 Index, the Nifty 500 Index is well-diversified, with its top 10 holdings accounting for only 37%, as opposed to 58% in the Nifty 50 Index. Furthermore, it provides diversified exposure to 21 sectors, some of the sectors includes textiles, consumer services, media, and forest materials that are not present in the Nifty 50 Index. The index offers an excellent blend of Largecap (75%), Midcap (16%) and Smallcap (9%)," according to Motilal Oswal Management Company. 
 

 Santosh Joseph, founder of Germinate Investor Services, believes for investors starting out, the Motilal Oswal Nifty 500 Index Fund can be a choice to capture the mid-cap and small-cap space in the passive side. Passive funds have become a favourite among young, new retail investors who want a simple, low-cost and hassle-free investment product. 

Index funds are loved by passive investors because they track a certain index and seek to produce returns that are comparable to those of the index they are tracking. In other words, index funds are mutual funds that invest in a set of stocks or asset classes that imitate the portfolio of a market index. While choosing the index funds, investors should look at the expense ratio and tracking error. The lower the expense ratio and tracking error of the mutual fund scheme, the better it is for the investor.

Currently there are two products in the market that track the Nifty500. One is the Motilal Oswal Nifty500 Index fund, and the other is a recently launched ETF. 

Broadly, if you are seeking convenience, index funds are likely to be the right choice. But if you want a cost advantage, ETFs are likely to be the better alternative.

"if investors prefer buying through exchanges, ETFs are a suitable choice. However, most investors typically lean towards Index funds. These funds offer the advantage of easy setup for SIPs, and investors do not need to concern themselves with execution or liquidity issues," said Pratik Oswal, Head of Passive Funds, Motilal Oswal Asset Management Company.

The Motilal Oswal Index fund gives an investor exposure to the top  500 stocks in the country.

Is it better than a Nifty50 Index?

"While the Nifty 50 offers stability and reliable dividends, the Nifty 500 index fund provides a wider market exposure and growth opportunities. Nifty 500 investors require better understanding and research before investments as it includes 400 mid-and small-cap companies, where investment risks are considerably higher as compared to the 100 large-cap companies. Note that an index such as this is weighted towards the 100 large companies that would form over 70% of the index, while the other 400 smaller companies would form the rest.

Investors looking to invest in a passive fund and capital appreciation over long horizons with diversification may consider such funds if they want exposure to the entire stock market through a single instrument," said Adhil Shetty, CEO of Bankbazaar.com

 However, you must remember that you must consider this option when you have a high to very high-risk appetite. If you’re looking to get started with equity, consider starting small, developing a familiarity with risks and rewards, and scaling your investment as appropriate for your risk profile and investment goals.

Only suitable for those seeking broader equity returns

"Investing in a Nifty 500 index fund can be a great option for passive investors seeking broader equity market returns. However, it's important to note that this approach is in contrast to generating alpha by not owning the entire market. For those who prefer a more active allocation, consider investing in focused, multicap, and flexicap funds to generate a sizeable alpha over the long term. Keep in mind, the amount and allocation of your investments depends on your individual risk profile. As with any investment, there are no guarantees, and Nifty 500 index funds carry similar market risks as other equity mutual funds," said  Deepak Gagrani,  Founder of Madhuban Finvest.

Even Mayank Bhatnagar, Chief Operating Officer, FinEdge believes that such an index fund would lead to over diversification. "You would be much better off investing into a mix of index funds that focus on large-cap stocks (such as the NIFTY 50 or the NIFTY Next 50), combined with actively managed small cap, mid cap or thematic funds that have a long-term track record of stock picking-led outperformance," said Bhatnagar.

Bhatnagar believes index funds are a viable replacement for large-cap funds, due to their relative cost-effectiveness and limited scope for actively managed blue-chip funds to outperform indices. However, beyond blue chips, there lies significant scope for generating index-beating returns from active management strategies across more focused bets, and investors would be missing out on that by limiting themselves to an index fund that is diversified across 500 shares.