The Volatile Index

Over the past few years, passive investing has taken off and now make up nearly 15% of the total AUM of the mutual fund industry. This is both equity and debt. Let’s park passive debt funds aside for now. In equity, Nifty 50 index funds are among the most popular, followed by Nifty Next 50 index funds.

The latter is a basket of future ‘blue chip’ stocks. But here is the kicker, more than 50% of India’s market capitalization is captured by #Nifty50 stocks, and nearly 12%-15% is covered by the Nifty Next 50 stocks. This means the top 100 stocks cover nearly two-thirds of the market capitalisation of the Indian listed shares space.

But the Nifty Next 50 (Nifty Junior) is more volatile than the Nifty 50, and only beats the Nifty 50 over a really long period of time in terms of returns. In the shorter term, say up to 5 years, the Nifty 50 is less volatile in terms of returns. In the past month, the Nifty Next 50 is down 8.8% while the Nifty 50 is down 1.29%.

What’s up with the Nifty Next 50 index?

If you’re wondering why we are talking about the Nifty Next 50, or Nifty junior, it’s because this index was hit hard by the turmoil in the Adani Group stocks over the past couple of weeks. Five Adani Group stocks are part of this index, with a weight of a little over 10% at the end of January 2023. The funds that track the index had an #AUM of almost Rs 13,000 crore.

At the end of December 2022 Adani Group stocks ( Adani Total Gas, Adani Green Energy, Adani Transmission, ACC and Ambuja Cements) had a weight of 14.1% in the Nifty junior. Some of this is due to a fall in the value of the stocks’ value.

The idea of investing in funds that directly track an index is to achieve adequate diversification of your mutual fund investments. But a lot of advisors and wealth managers suggest Nifty 50 funds to investors. But because of the possibility of the outsized returns in the Nifty Next 50 (with its associated volatility) some investors have flocked to this category too.

Therein lies the rub.

Active vs Passive plays out

Index funds held on to their holdings in #AdaniGroup stocks, which were getting hammered by the markets over the past few weeks. The Nifty 50 has only 2 stocks, with quite a small weight, hence the index recouped its losses after a few trading sessions. Active fund managers took the volatility as an opportunity to snap up shares of some Adani Group companies like Adani Ports, ACC, Ambuja Cements, among others.

This is what puts the conflict between being a passive vs an active fund investor into focus. If you were an investor in passive funds, your holdings would contain Adani Group stocks, at a lower market price. But an active fund manager can buy the same stocks for cheaper, which your index fund holds at a higher cost.

This means an active fund manager can pounce on an opportunity with high volatility to snap up stocks that suddenly are available at reasonable valuations. These short term movements can make a portfolio made out of index funds a little wonky for a very short period of time.

This is where having a financial advisor or a mutual fund distributor helps. They will be able to tell you how much of your portfolio should be indexed through a passive vehicle, and how much you should earmark for active funds.

Lastly, the Nifty junior index has two types of stocks that want to be blue chips–the one on the way up, and the other on the way down. This means a stock that might eventually get booted out of the index will also get new investments through a passive scheme if many investors choose to stagger their investments through SIPs.

That’s another reason to have an advisor to have your back who tells you which funds you should stick to and those you should pass on. If you have an advisor, always consult one before taking major investment decisions.

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