Weekly Musings – NFO Pick (Nippon India Nifty 500 Equal Weight Index Fund)

20 Aug 2024 , 09:36 PM

WHAT IS EQUAL WEIGHT INDEXING ALL ABOUT?

Equal weight index is a strategy of replicating the index in terms of composition. However, unlike the free-float market cap weights given to any typical index, an equal weight index gives equal weight to all the components. Here is what you need to know.

• Equal weight index is a unique approach to index investing where each component is assigned the same weight in the portfolio. If there are 50 stocks in the index, then each stock gets 2% weightage in the portfolio.
• The equal weight index is agnostic to either the market capitalization of the stock in the index or its free float. This makes the selection much fairer as smaller companies also stand a strong chance of good representation.
• In the traditional indexing approach, the companies with a bigger market and bigger free float get more weightage compared to the smaller companies. Hence, the focus is not on the composition of the index but on the handful of heavyweights in the index.
• These indices are continuously rebalanced to ensure that the equal weights are maintained. This also becomes a sort of auto profit booking. This automatically favours lower valuation stocks over higher valuation stocks.

In this case, the Nippon India Nifty 500 Equal Weight Index Fund is benchmarked to the Nifty 500 Equal Weight TRI index.

WHAT YOU MUST KNOW ABOUT NIFTY 500 EQUAL WEIGHT INDEX

The Nippon India Nifty 500 Equal Weight Index Fund being an equal weight index fund, let us first understand what exactly is an equal weighted index. Here are some key takeaways.

• The Nifty 500 Equal Weight Index provides an equal opportunity for all stocks irrespective of size and free float to be represented in the portfolio of the fund. Hence, this approach reflects the performance of the portfolio mix rather than few stocks.
• The Nifty 500 Equal Weight Index has a dual level of diversification. Firstly, it is diversified due to a large portfolio of 500 stocks. More importantly, the equal weight does not bias the index in favour of the handful of very high market cap stocks.
• The Nifty 500 Equal Weight Index makes a balanced portfolio choice from among the large caps, mid-caps, and small caps. It considers a total of 100 large caps, 150 mid-caps and 250 small caps, so there is adequate representation across the board.
• The rigor of index selection is still there which is the Nifty 500. However, the only difference in the equal weight index is that it assigns equal weights to all the components and also rebalances on a period basis to avoid value bias.
• This gives a 20:30:50 split between large caps, mid-caps, and small caps; making it an agnostic fund with the characteristics of all kinds of stocks. Also, the rebalancing is an automatic profit booking mechanism in the portfolio.

Let us now turn to how the two Nifty 500 indices compare?

COMPARING EQUAL WEIGHT NIFTY 500 WITH NIFTY 500

The traditional Nifty 500 index and the Nifty 500 Equal Weight index have some stark differences, which is what makes the equal weight index fund special.

• In the traditional Nifty 500 index, the top 100 stocks account for 74% of the overall market cap of the index. However, in the Nifty 500 Equal Weight index, the top 100 stocks only account for 20% of the market cap of the index as a whole. This reduces the concentration risk in the portfolio that is benchmarked to the index.
• The Nifty 500 Equal Weight Inde has a bias towards mid-caps and small caps. For instance, if you combine the large caps and the mid-caps in the traditional Nifty 500 index, they make up 90.3% of the index market cap. In the equal weight index, the large caps and mid-caps together only make up 50% of the index market cap. The equal weight is not only biased away from large caps, but also offers more variety.
• Let us look at how the exposure of some key sectors gets impacted. Financial services has 27.6% weight in the Nifty 500 but just 18.1% in the equal wight index. Capital Goods has just 5.9% weight in the Nifty 500 but 11.8% in the equal wight index. Healthcare has just 5.7% weight in the Nifty 500 but 9.5% in the equal wight index. Chemicals has 2.2% weight in the Nifty 500 but 7.0% in the equal wight index. Apart from BFSI, the weight of autos, FMCG and IT also comes down in the equal weight index.

Let us turn to the million dollar question. Does equal weight really impact the performance of the fund positively?

EQUAL WEIGHT HAS RESULTED IN BETTER PERFORMANCE

If you go by the empirical data, then equal weight index has given a better performance compared to the market cap weighted index. Here are some key observations.

• How did the equal weight Nifty 500 compare with the returns of the Nifty 500 index. Over a 1 year period, the returns on the equal weight index and the Nifty 500 index were 56.6% and 39.2% Over 3 years; it was 25.9% and 21.0% while over 5 years; it was 30.6% and 22.3% respectively. Over a 10 year period, an investment of ₹10,000 would have grown to ₹42,000 on the Nifty 500 but would have grown to ₹48,000 on the equal weight Nifty 500. In short, the equal weight Nifty 500 has outperformed the Nifty 500 index across all time frames.
• If you look at the last 19 years since 2005, the Nifty 500 Equal Weight index has given positive returns in 14 out of the 19 years, with average CAGR annualized returns of 23%. Even on a rolling returns basis, the equal weight index has done better than the Nifty 500 index.

To sum up the story, the advantages of investing in the Nippon India Nifty 500 Equal Weight Index Fund NFO is not just about the returns, but about other factors too. It offers the opportunity to participate in a large universe of carefully selected stocks, offers inbuilt diversification of portfolio, reduces risk, enhances cyclical value through SIPs and offers the benefit of much lower costs.

GLANCE AT THE NIPPON INDIA NIFTY 500 EQUAL WEIGHT INDEX FUND NFO

Here are some details of the Nippon India Nifty 500 Equal Weight Index Fund NFO you must know to decide on investing in the fund.

• The NFO of Nippon India Nifty 500 Equal Weight Index Fund opens for subscription on August 21, 2024 and will close on September 04, 2024. Being an open-ended index fund, with equal weight to the Nifty 500 stocks, it will reopen for sale and repurchase anywhere between 3 days and 15 days of NFO closure. The Nippon India Nifty 500 Equal Weight Index Fund is best suited to investors looking for a passive approach to participating in the broad-based Indian market, without the risk of investment decisions being distorted by the free float market cap weighting.
• The core focus of the Nippon India Nifty 500 Equal Weight Index Fund is to track the Nifty 500 index with a slightly different approach. While the components of the index will constitute the portfolio, the weightages will be equal weighted, rather than market cap weighted. The focus will be on long-term capital appreciation, through a partially passive approach to investing in the Indian markets. Hence, a holding period of 5-7 years at the bare minimum would be required to realize the full benefits.
• On the Standard SEBI Risk-O-Meter, the Nippon India Nifty 500 Equal Weight Index Fund will be ranked as a Very High Risk Fund. The high risk is an outcome of the predominant exposure to equities (95% to 100%) that the Nippon India Nifty 500 Equal Weight Index Fund will have. In addition, there is the risk of entering into the markets at lifetime highs as well as the risk that the equal weight approach may not be able to genuinely outperform the market cap weighted index approach.
• The Nippon India Nifty 500 Equal Weight Index Fund is about generating long term capital growth with an equal weighted portfolio of the Nifty 500 Index stocks. The focus will not be on stock picking but on buying up the entire components of the index in equal proportions. It will have a very balanced mix of large caps, mid-caps, and small caps in the overall portfolio, reflecting the composition of the Nifty 500 index.
• Investors can invest in the NFO of Nippon India Nifty 500 Equal Weight Index Fund in minimum size of ₹1,000 lumpsum and in multiples of ₹1 thereof. This also applies to additional purchases and switch-ins. The fund also supports the systematic investment plans (SIPs), systematic withdrawal plans (SWP), and the systematic transfer plans (STPs) programs on a structured and long term basis.
• There is no entry load, and there will also be no exit load on the fund selling irrespective of the holding period. Being an index linked fund, the endeavour is to keep the net cost to the customer as low as possible and hence exit loads have been waived. However, irrespective of the exit loads not being there, investors are advised to stay invested in this fund for a minimum period of 5-7 years to realize the full benefits of the strategy of equal weighting outperforming the broad-based Nifty 500 index.
• The Nippon India Nifty 500 Equal Weight Index Fund does not give any guarantee on returns and the performance of the fund is subject to the vagaries of the markets in general and the performance of the Nifty 500 index in particular. The Nippon India Nifty 500 Equal Weight Index Fund will be benchmarked to the Nifty 500 Equal Weight TRI, which it will seek to replicate in composition. This fund does carry the risk of tracking error but will try to minimize the tracking error compared to the Nifty 500 Equal Weight TRI index to the extent possible.
• The Nippon India Nifty 500 Equal Weight Index Fund will be managed by Himanshu Mange and his team. The intent of the fund management team will be replicate the Nifty 500 Equal Weight TRI and keep the tracking error at the bare minimum. KFIN Technologies Ltd will be the registrars to the fund.

The Nippon India Nifty 500 Equal Weight Index Fund NFO offers an opportunity for investors to participate in the upside opportunity in the Indian markets as the economy transitions from being a $3.5 Trillion economy to a $5 Trillion economy. This comes with its risks, but the bet is that over the longer term of around 7 years plus, these cycles would even out.

TAX TREATMENT FOR NIPPON INDIA NIFTY 500 EQUAL WEIGHT INDEX FUND

Post the Union Budget announced on July 23, 2024; there are some key changes to the way the returns earned on the Nippon India Nifty 500 Equal Weight Index Fund will be taxed. Being an equity index equal weight fund, it will be taxed at par with equities under the Income Tax Act.

• The demarcation holding period for short term and long term capital gains is 1 year. If the Nippon India Nifty 500 Equal Weight Index Fund is held for 1 year or more, it will qualify as long term capital gains. Capital losses can be written off against gains and also carried forward.
• The dividends declared by the fund, if any, will be taxed at peak rate of tax applicable. In addition, if the overall dividends exceed ₹5,000 in a year, they will be subject to tax deduction at source (TDS), under the extant income tax rules.
• STCG tax treatment has undergone a change in the July 23, 2024 Union Budget. The short term capital gains on units sold before 1 year will be taxed at 20% on gains plus cess at 4%, making effective STCG rate 20.80%. It was raised from the old rate of 15%.
• The LTCG will be taxed at a flat rate of 12.5% (up from 10%). However, threshold exemption limit has also been increased from ₹1 Lakh to ₹1.25 Lakhs. Even in this case, the actual tax impact will be 13% after including the 4% cess.

Investors need to factor in the changed taxation rules before investing in the Nippon India Nifty 500 Equal Weight Index Fund and understand the implications on post-tax returns.