Your Questions Answered: Is investing in mutual fund tracking Nifty 100 Equal Weight Index a good choice?

I am a fresher working with a Venture Capital fund in Bengaluru. I have been investing In Nifty 50 and Sensex tracking index mutual funds for the past 6 months. I wish to now diversify to other mutual funds. However, I wish to invest only in the large-cap sector. Many of my acquaintances have suggested investing in the Nifty 100 Equal Weight Index. However, I am not familiar with it. Can you please elaborate on the pros and cons of investing in a mutual fund tracking the Nifty 100 Equal Weight Index and how it is different from the Nifty 100 Index?

J. Arunachalam, Bengaluru, Karnataka

The Nifty 100 Equal Weight Index is a unique index developed by the National Stock Exchange of India Limited (NSE) that offers a unique perspective on the Indian equity market specifically on the large-cap sector. Unlike traditional indices, which are typically weighted by market capitalisation, the Nifty 100 Equal Weight Index assigns an equal weight to each of its constituents. This means that each company, regardless of its size, has an equal influence on the index's performance.

What are equal weight indices?

Equal weight indices are based on the idea that giving each stock the same weight allows for a more diversified portfolio and can potentially reduce the risk of market volatility affecting the index's performance. This approach contrasts with market-cap-weighted indices, where larger companies can significantly sway the index, potentially leading to higher concentration risk.

Investment options

For investors interested in the Nifty 100 Equal Weight Index, there are multiple mutual funds that aim to replicate the performance of the Nifty 100 Equal Weight Index.

The future of equal-weight indices

The Nifty 100 Equal Weight Index represents a shift in investment philosophy, moving away from the dominance of a few stocks towards a more balanced approach. As the financial markets evolve, equal-weight indices like the Nifty 100 Equal Weight Index may become more popular among investors looking for diversified exposure to the Indian equity market. The Nifty 100 Equal Weight Index offers an alternative to traditional market-cap-weighted indices, providing a way to invest in the Indian equity market with a focus on diversification and equal representation. Its performance and the investment vehicles that track it make it a noteworthy option for investors exploring the Indian stock market landscape.

Understanding the Nifty 100 Equal Weight Index eligibility criteria

Unlike traditional indices that weigh constituents based on their market capitalisation, the Nifty 100 Equal Weight Index assigns an equal weight to each of its components, ensuring a balanced representation that mitigates the influence of larger companies.

The eligibility criteria for inclusion in the Nifty 100 Equal Weight Index are as follows:

Part of Nifty 500: To be considered for the Nifty 100 Equal Weight Index, a company must already be a part of the broader Nifty 500 index.

Ranking based on full market capitalisation: Companies are selected based on their full market capitalisation ranking. To be included, a company's rank based on full market capitalisation must be within the top 90.

Market capitalisation threshold: There is also a market capitalisation threshold that must be met. A company's full market capitalisation should be at least 1.50 times that of the last constituent in the Nifty 100.

Liquidity and trading frequency: Liquidity is a crucial factor, and companies must exhibit a certain level of trading frequency and liquidity to be eligible.

Free-float market capitalisation: The average free-float market capitalisation of a company is also considered, and it must rank among the top 800 companies based on this criterion for the last six months.

Listing history and impact cost: A company's listing history and impact cost are taken into account, ensuring that only those with a stable and established presence on the NSE are included.

Domicile: Lastly, the domicile of the company is considered, with the requirement that the company must be listed on the NSE.

The Nifty 100 Equal Weight Index serves various purposes, such as benchmarking fund portfolios, launching index funds, ETFs and structured products. The Nifty 100 Equal Weight Index represents a strategic choice for investors who value equal representation across various sectors and companies, regardless of their size. Its eligibility criteria ensure that the index is composed of companies that are not only significant in terms of market capitalisation but also meet stringent requirements regarding liquidity, trading history, and financial stability.

Performance, returns and comparison with Nifty 50

As of August 3, 2024, the Nifty 100 Equal Weight Index has given a one-year return of 54.25%. It has given a 5 year compounded annual return of 23.13%. On the other hand, as of June 28, 204 Nifty 50 Index has given a one-year return of 32.64%. It has given a 5 year compounded annual return of 19.39%.

Note: Past performance is not an indication of future returns.

Pros and cons of investing In index mutual funds tracking Nifty 100 Equal Weight Index

Investing in index mutual funds that track the Nifty 100 Equal Weight Index can be an attractive option for investors looking to diversify their portfolio and gain exposure to the Indian equity market. These funds offer a unique approach by assigning equal weight to each stock in the index, regardless of the company's market size. This method contrasts with traditional market capitalisation-weighted indices, where larger companies have a more significant impact on the index's performance.

Pros

Diversification: One of the primary advantages of these funds is the diversification they offer. By investing in a fund that tracks the Nifty 100 Equal Weight Index, investors can spread their risk across 100 different companies, reducing the impact of any single stock's performance on their overall investment.

Performance potential: Historically, equal-weighted index funds have shown the potential to produce superior returns compared to their market-cap-weighted counterparts this is especially true in the case of the Nifty 100 Equal Weight Index and has been discussed later in this blog. This is because the performance of smaller companies has a more significant impact on the index, which can lead to higher returns if these companies perform well.

Simplicity: Investing in an index fund is a straightforward way to gain exposure to a broad range of assets. Investors know exactly what they are investing in and can easily track the performance of their investments.

Lower costs: Index mutual funds typically have lower expense ratios than actively managed funds because they are passively managed. This means that more of the investor's money is working for them, potentially leading to better net returns.

Cons

Volatility: The Nifty 100 Equal Weight Index can be more volatile than market-cap-weighted indices. This is because the performance of smaller companies, which have a greater impact on the index, can be more unpredictable.

Key differences between the Nifty 100 Index and the Nifty 100 Equal Weight Index

Investing in the stock market involves a plethora of choices, especially when it comes to indices. The Nifty 100 Equal Weight Index and the Nifty 100 Index may sound similar, however, there are multiple differences that investors should be aware of.

Weightage: In the Nifty 100, companies with higher market capitalisation have a greater impact on the index's movement. Conversely, in the Equal Weight Index, all companies contribute equally to the index's performance.

Rebalancing: The Equal Weight Index is rebalanced periodically to maintain equal weightage. This involves buying shares of underperforming companies and selling shares of outperforming ones, which can lead to a contrarian investment approach.

Performance: Historically, the Nifty 100 Equal Weight Index has shown a tendency to outperform the Nifty 100 Index over certain periods.

Volatility: The Nifty 100 Equal Weight Index has shown higher levels of volatility over the year.

Diversification: The Equal Weight Index offers better diversification as it prevents the index from being overly influenced by a few stocks.

Which one to choose?

The choice between the Nifty 100 and the Nifty 100 Equal Weight Index depends on the investor's strategy and preference for market exposure. The Equal Weight Index may appeal to those looking for a more balanced approach, while the Nifty 100 might be preferred by those who believe in the market-cap-weighted philosophy. In conclusion, both indices offer unique advantages and cater to different investment styles. Understanding these differences is crucial for making informed investment decisions.

Understanding the taxation of investments in mutual funds tracking the Nifty 100 Equal Weight Index post the latest budget

The latest budget has brought about significant changes in the taxation of mutual funds, especially those tracking the Nifty 100 Equal Weight Index. Investors looking to understand the impact of these changes on their investments will find that the new regulations can influence both the strategy and the returns of their mutual fund investments.

Long-term capital gains tax

Investments in mutual funds are subject to LTCG tax if the units are held for more than one year. The latest budget has revised the LTCG tax rate on equity mutual funds to 12.5% from 10% on gains exceeding ₹1.25 lakh in a financial year. This is a critical change for investors to consider when planning their investments and returns.

Short-term capital gains tax

If the units of the mutual fund are sold within a year from the date of investment, the gains are taxed at 20%. This remains unchanged and continues to incentivize long-term investments over short-term trading.

The latest budget has introduced changes that could impact investors in mutual funds tracking the Nifty 100 Equal Weight Index. It's crucial for investors to stay informed about these changes and consult with financial advisors to understand the implications for their investment portfolios. With careful planning and strategy, investors can navigate the new tax landscape and continue to make informed investment decisions.

In conclusion, index mutual funds tracking the Nifty 100 Equal Weight Index offer a balanced approach to investing in the Indian equity market. They provide diversification, the potential for higher returns, simplicity, and lower costs. However, investors must also consider the limitations, such as increased volatility, and a limited track record. As with any investment, it is crucial to align fund choices with individual financial goals, risk tolerance, and investment horizon.

Kuvera is a free direct mutual fund investing platform. Unless otherwise stated data sourced from BSE, NSE and kuvera