5 things not commonly known about the NIFTY

The Calm Investor | 5 things not commonly known about the NIFTY

Earlier this week, NSE announced effective Sep 29, 4 stocks (ACC, Bank of Baroda, Tata Power, Tata Motors DVR) will be dropped and 3 (Bajaj Finance, Hindustan Petroleum, UPL) will be added to the NIFTY.

When analysts talk about the performance of the “Indian Stock Market”, they are typically talking about the NSE NIFTY Index, and the BSE Sensex Index (to a lesser extent). Most investors know the NIFTY consists of 50 stocks (currently 51), of the largest companies by market capitalisation trading on the Indian markets.

5 things not commonly known about the NIFTY:

5. How the NIFTY 50 is decided

The NIFTY started in 1996 as a full market-capitalisation weighted index, i.e. (number of shares outstanding X share price) to find largest companies by full market capitalisation. In June 2009, it shifted to the float-adjusted market-capitalisation weighted methodology, i.e. (number of shares available for trading X share price). This method excludes the shares owned by promoters to include only companies with significant number of shares available to outside investors and traders. This ensures liquidity and therefore lower price volatility.

The stocks in the index account for approximately 65% of float-adjusted market cap of the 1600 companies listed on the NSE

4. What NIFTY “levels” mean

The base period for the NIFTY 50 index is November 3, 1995, which marked the completion of one year of operations of NSE’s Capital Market Segment. The base value of the index was set at 1000, and a base capital of Rs 2.06 trillion (Rs 206,000 Crores).

NIFTY Index level at any given instant  = Current Market Capital / Base Capital X Base Index Value (1000)

Note how NIFTY levels only consider price movements and not dividends received. NSE also offers the Total Returns Index that addresses this drawback in calculating total returns. As a thumb rule, add 1 – 1.5% to NIFTY return to arrive at actual return.

3. The NIFTY changes often

For a stock to be included in the NIFTY, it must have at least twice the float-adjusted market cap of the current smallest index constituent.

Since 1996 when the NIFTY was formed, the Index Maintenance Sub-Committee  reviews the index twice a year, and has made on average four changes to the index composition every year (maximum 7 in 2002 and 1998, minimum 0 in just once in 2000). With the recently announced changes, the YTD number for 2017 is at 7.

That’s 89 changes to the index over 22 years. If you were replicating the NIFTY, you’d be replacing 10-12% of your portfolio every year

2. NIFTY gives second chances

Eight stocks have entered / exited the NIFTY more than once:

  • Asian Paints (In: Sep 1996, Out: Oct 2002, In: Apr 2012)
  • Bharat Petroleum Corporation Ltd. (BPCL) (In: Dec 1997, Out: Oct 1998, In: Oct 2002)
  • Dr. Reddy’s Laboratories (In: Inception, Out: May 1997, In: May 1999, Out: Sep 2008, In: Oct 2010)
  • Grasim Industries (In: Inception, Out: Apr 2010, In: Mar 2011, Out: May 2017)
  • Idea Cellular (In: Dec 2007, Out: Oct 2010, In: Mar 2015, Out: Mar 2017)
  • Reliance Capital (In: Inception, Out: May 1999, In: Jan 2009, Out: Oct 2011)
  • Reliance Petroleum (In: Inception, Out: Oct 2002, Apr 2007, Out: Jul 2009)
  • Wipro (In: Jan 2002, Out: Apr 2013, In: Sep 2013)

A stock exiting the NIFTY doesn’t necessarily mean it’s long term prospects are poor.

1. Inclusion in the NIFTY does not guarantee longevity

You’d expect companies carefully handpicked on the basis of their market cap and their recent stock performance can be trusted to be around for the long haul. They are, after all, the largest in their respective sectors. Yet, almost 15 of the ~90 companies that were added to the NIFTY at some point do not exist today. While most of them were merged into parent companies, some were bought by competition after falling behind.

Examples of companies no longer listed:

  • Andhra Valley Power Supply: Tata group company merged into one entity in 2000
  • Brooke Bond Lipton India: Delisted after merger with Hindustan Lever Ltd in 1996
  • Cairn India: Merged with parent company Vedanta in 2017
  • Digital Equipment (India) Ltd: No information available
  • Digital Globalsoft: Delisted after combining with parent company Hewlett Packard
  • Essar Gujarat: Delisted in 2005
  • Indian Petrochemical Corporation: Merged with Reliance Industries in 2007
  • Indian Rayon and Industries, Indo Gulf Corporation: Merged with other entities to form Aditya Birla Nuvo in 2005
  • Sesa Goa: Acquired by Vedanta Ltd in 2007
  • Ponds (India): Acquired by HUL in 1987

Finally, when comparing investment performance with the NIFTY

While the NIFTY is a good benchmark to compare your investments against, important to keep in mind:

  1. stocks get included in the NIFTY after they appreciate significantly – the sector and it’s stocks could be flavour of the month / quarter leading to price appreciation
  2. failing companies are dropped as their market caps fall – survivorship bias, implying the ~15% annual return of the NIFTY excludes the losers

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