Nifty’s Metamorphosis – The Hindu

The Nifty Index is one of the most viewed and discussed indices in India. This index has become the only torchbearer to measure the overall performance of the market. Much of the portfolio allocation and valuation is based solely on this index.

The purpose of this article is to analyze the index in a granular way so that any analysis produces the desired results.

The index was introduced in 1996 and includes companies of weight in terms of full market capitalization. However, in June 2009, it switched to the free float-adjusted market capitalization-weighted methodology of the full market-capitalization-weighted index.

Market capitalization, or market capitalization, refers to the total market value of a company’s outstanding shares. It is obtained by multiplying the total number of shares outstanding by the current market price of a share. The free float methodology uses the value derived from multiplying the share price by the number of publicly held, unrestricted shares available in the open market. Generally, these are farms other than those of the promoters.

Because of this fundamental change that took place in June 2009, there have been big winners and big losers. Some of the notable changes that were seen at the time included both NTPC and ONGC losing more than 10 percentage points in weight in Nifty at the time, ONGC dropping from 8.9% to 3% and NTPC from 6.3% to 1.4% immediately after the change. TCS also lost weight from 2.47% to 1.55%.

The weight of Infosys, ICICI Bank, L&T and HDFC Binoculars increased by around 2-5%. L&T saw its weight increase from 2.9% to 7.8%.

The weight of the top 10 stocks in the index fell from 53% to 59% as a result of these changes.

In this evolving Nifty Index, both companies and their weightings have increased or decreased dramatically over the past decade.

Becoming important

Stocks such as HDFC Bank, HDFC Ltd. and TCS have steadily grown in importance over the past 15 years. To put it in perspective, HDFC Bank’s weight has dropped from 4.38% to 11.2% (maximum weight) and is currently at 8.8%.

ONGC, which benefited from a 15% weighting in 2004, currently only has 0.7% weight in the index. Likewise, the weight of NTPC dropped from a high of 7.1% to 0.8%.

No less than 26 stocks that were part of the Nifty index in 2004 are no longer part of the index now. Examples are BHEL, Colgate and MTNL.

Over the past three years, stocks such as Nestlé, Britannia, Tata Consumer, Shree Cement, HDFC and SBI Life and Divi’s have been valued at higher multiples due to strong balance sheets and cash flow metrics, doing so climb the valuation of the index without any fundamental data. change in the price of the underlying stock.

The banking index had assumed considerable importance, its weight having fallen from 11% to 35% over the past 15 years. Oil and gas lost weight by 17% to 0.7%. The software can be described as “stable on the rise” and the weights of FMCG have increased. Telecommunications and electricity lost more than 5 percentage points collectively.

Strongly asymmetric

What investors should note is that the index is certainly diversified, but only by name and not by weight.

The composition of the index is heavily skewed in favor of a handful of stocks. About 50% of stocks have no meaningful representation. There are 24 stocks that each have less than 1% representation while the 25 lowest stocks represent a paltry 17% of the total index weighting. Even though new names are added to Nifty every six months, a few large cap stocks are given a large weight.

Key points to remember

The asset allocation model based on the Nifty valuation must keep these changes in perspective to fit the model outcome. All recent additions to the index come from sectors that tend to have higher multiples, resulting in higher valuations, for example Britannia Industries and Nestlé India.

Additionally, as the weighting of bank stocks in the index has increased significantly, the PE ratio becomes slightly irrelevant as banks are primarily valued on a price / book basis.

To facilitate the creation of investment models, Nifty valuation ratios such as PE ratio can be reconstructed using current Nifty stocks instead of old stocks to get a better perspective of historical valuation.

The weight of the HDFC group has increased from 3.3% to 16.3% over the past 15 years. Funds overweighted or underweighted in these three stocks had very different results. Over the past 12 months, all three HDFC group stocks have underperformed the benchmark by 8-25%. Due to their heavy weighting in Nifty and widely held stocks, this had a significant impact on the performance of the portfolio. A strategic call should be taken by portfolio managers to ensure that they are not caught off guard. Likewise, the weight of the shares of the Tata group also increased with five shares weighing 9.1%.

No stock has been able to maintain the top spot on the index for periods of five years from ONGC (2004) to Reliance Industries (2009) to ITC (2014). Currently, Reliance enjoys greater weight.

The index is heavily biased in favor of financials (credit companies). Since one-third of the index’s weight is in financials, any deterioration in the banking sector will have a significant impact on the index.

The nine financial stocks in the index generate 1.37 lakh of profit, which is about 25% of the total profit of the Nifty 50 companies.

With new developments in open credit frameworks and account aggregators, and the rise of fintech (we have a total of 16 fintech companies reaching ‘unicorn’ status with an aggregate value of over $ 60 billion. dollars), their valuations reflect the higher competitive intensity expected on banks’ profit pool fees over the medium term. It is important for long-term investors to have a balanced approach to sectors where there is a higher degree of competitive intensity to generate sustainable returns.

Sectors less correlated with banking, such as pharma, IT and those with an export theme, must find a strategic place for good valuations in the investment portfolio to prevent it from being dragged into excessive intermediate volatility.

(The author is head of research and co-manager of the fund, ithought Advisory)

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