Equal-weight funds outdo benchmarks
Broad-based rally in domestic equities has helped equalweight funds steal the thunder from their underlying market capitalisation-weighted indices.
Over the past year, DSP Equal Nifty 50 Fund, Principal Nifty 100 Equal Weight Fund, and Sundaram Smart Nifty 100 Equal Weight Fund have generated returns in the range of 41-46 per cent. In comparison, the Nifty and the Nifty 100 indices have gained around 34 per cent each.
An equal-weight index assigns an equal weighting to all the components of the index. On the other hand, in a conventional m-cap-weighted index, the weighting is decided by the market value of the underlying stock.
To illustrate, the Nifty100 index has 100 underlying stocks. An equal-weight index will assign 1 per cent weighting to all the 100 stocks. The m-cap-based index considers free-float market cap of all the stocks. The weighting of an individual stock is its freefloat market cap as a percentage of the cumulative freefloat market cap.
Index funds and exchange-traded funds (ETFS) tracking these indices try to mimic the returns of the underlying indices.
Anil Ghelani, head of passive investments at DSP Mutual Fund says that the basic principle of investing is that one should invest in good companies which are leaders in the sectors and secondly portfolio should be welldiversified.
“While the Nifty 50 meets the first criterion, but the index is heavily tilted towards a few sectors, such as financials, oil & gas, and IT. So, this fund invests equally across all the 50 stocks in the Nifty index and broad-based rally in the past year has helped the fund to deliver better returns,” he says.
DSP Equal Nifty 50 Fund rebalances the portfolio every quarter and has an allocation of 2 per cent across the 50 stocks of the index.
Over the past few months, most of the bottom 30 stocks of the Nifty50 have seen a sharp run, bolstering returns of equal-weight funds.
“While our fund had only 2 per cent exposure to some of the top names of the index, strong performance across the sectors in the index has helped the fund. With strong flows coming from foreign portfolio investors and earnings of companies also improving across the market capitalisation, we believe that broad-based rally is likely to continue,” says Ghelani.
Since 2018, the Indian markets had seen sharp polarisation as only dozen-odd stocks were delivering the returns in the benchmark indices. In such times, the returns of equal-weight funds tend to lag that of the main indices.
Equal-weight funds do well only when there is a broadbased rally, and underperform when only a few stocks drive up the market.
“The kind of volatility we have seen in the last few months have ensured that equal weight indices have done better as they work on the principle of curtailing the fall. This strategy doesn’t give as much returns when there is a high one-sided rally and historically, we have seen marketcap based investing working better than equal weight indices,” said Vidya Bala, cofounder of Primeinvestor.