The metamorphosis of Nifty

The index has witnessed many changes since its inception in 1996

One of the most widely watched and discussed indexes in India is the Nifty index. This index has become the sole torchbearer for gauging the overall performance of the market. Much of portfolio allocation and valuation are solely based on this index.

The purpose of this article is to analyse the index in a granular manner so that any analysis will yield desired results.

The index was introduced in 1996 and comprises heavyweight companies in terms of full market capitalisation. However, in June 2009, it shifted to the float-adjusted market capitalisation-weighted methodology from the complete market capitalisation-weighted index.

Market capitalisation, or market cap, refers to the total market value of a company’s outstanding shares of stock. It is arrived at by multiplying the total number of outstanding shares by the current market price of a share. The float-adjusted methodology uses the value derived from multiplying the share price by the number of shares that are publicly-owned, unrestricted and available on the open market. Generally, these are holdings other than those of the promoters.

Due to this fundamental change which took place in June 2009, there were big winners and losers. A few of the noteworthy changes that were seen then included both NTPC and ONGC which together lost more than 10 percentage points weight in Nifty at the time, with 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 the HDFC twins increased in the range of 2-5%. L&T saw a large increase in weight from 2.9% to 7.8%.

The weight of the top 10 holdings of the index increased from 53% to 59% due to these changes.

In this evolving Nifty index, both companies and their weightages either increased or decreased dramatically over the past decade or so.

Gaining prominence

Stocks such as HDFC Bank, HDFC Ltd. and TCS consistently gained prominence in the last 15 years. To put it in perspective — HDFC Bank’s weight increased from 4.38% to 11.2% (peak weight) and is currently 8.8%.

ONGC, which enjoyed 15% weightage during 2004, currently has only 0.7% weightage in the index. Similarly, NTPC’s weightage has come down from a high of 7.1% to 0.8%.

As many as 26 stocks that were in the Nifty index in 2004 are not part of the index now. Examples are BHEL, Colgate and MTNL.

In the last three years, stocks such as Nestle, Britannia, Tata Consumer, Shree Cement, HDFC and SBI Life and Divi’s were valued at higher multiples due to strong balance sheets and cash-flow metrics thus pushing up the the index valuation without any fundamental change in the price of the underlying stock.

The banking index had gained huge prominence with weightage having increased from 11% to 35% over the last 15 years. Oil and gas lost weight from 17% to 0.7%. Software can be termed ‘stable to upward’ and FMCG’s weights have risen. Telecom and power lost more than 5 percentage points collectively.

Heavily skewed

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

The composition of the index is heavily skewed towards a handful of stocks. About 50% of the stocks do not have any meaningful representation. There are 24 stocks which have less than 1% representation each while the bottom 25 stocks represent a meagre 17% of the total index weight. Even though new names are added to the Nifty every six months, large weightage is given to a few large cap stocks.

Key takeaways

The asset allocation model based on Nifty valuation has to keep these changes in perspective to adjust the model outcome. All the recent additions to the index have come from sectors generally having higher multiples, resulting in higher valuations, for example Britannia Industries and Nestle India.

Also, since the weightage of banking stocks in the index had risen significantly, the PE ratio is becoming slightly irrelevant as banks are primarily valued based on price-to-book.

For ease of building investment models, Nifty valuation ratios such as the PE ratio can be reconstructed by using current Nifty stocks instead of old stocks to get a better perspective of historical valuation.

HDFC group weightage has increased from 3.3% to 16.3% in the last 15 years. Funds which are either overweight or underweight in these three stocks have experienced vastly different outcomes. During the last 12 months, all three HDFC group stocks have underperformed the index benchmark in the range of 8-25% . Due to their large weightage in Nifty and stocks being widely owned, this has had a significant impact on portfolio performance. A strategic call has to be taken by portfolio managers to ensure that they are not caught off guard. Similarly, now the weight of Tata group stocks is also increasing with five stocks having 9.1% weight.

No stock has been able to retain the top position in the index for five-year periods starting from ONGC (2004) to Reliance Industries (2009) to ITC (2014). Currently, Reliance enjoys top weightage.

The index is highly skewed towards financials (lending companies). Since a third of the index weight is from financial stocks, any deterioration in the banking sector will have a telling impact on the index.

The nine financial stocks in the index generate ₹1.37 lakh crore of profit, which is approximately 25% of the total profit pool of 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 firms reaching ‘unicorn’ status with an aggregate value of $60 billion plus), their valuations reflect the expected higher competitive intensity on fee profit pool of the banks in the medium term. It’s important for long-term investors to have a balanced approach towards sectors where there is a higher degree of competitive intensity to build sustainable returns.

Sectors which have lesser correlation versus banking, such as pharma, IT and those with an exports theme, have to find a strategic place at right valuations in the investment portfolio to prevent it from getting drawn into undue interim volatility.

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

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