Should you invest in the HDFC NIFTY50 Equal Weight Index Fund's NFO?

How does it work?

Normally, Indices such as S&P BSE Sensex and Nifty 50 are constituted with the top stocks in terms of free float market capitalization. For instance, the top three stocks in the Nifty 50 index  – Reliance Industries, HDFC Bank and Infosys – had a weight of 10 percent, 9.6 percent and 8.6 percent as on June 30, 2021, while the bottom three stocks – IOC, Coal India and Shree Cement – had a weight of 0.4 percent, 0.5 percent and 0.5 percent, respectively. But in an equal weight index, all the stocks are treated equally by assigning the same weightage of 2 percent each. HNEWF has a provision for quarterly rebalancing. That means, when market prices of stocks increase, the excess percentage will be sold and vice versa. Since the fund will be rebalanced every quarter, periodic and regular profit-booking would follow.

What works and what doesn’t

Since the stocks are weighted equally, the cost of acquisition in the lower market-cap stock is low. Ideally, such bluechip lower market-cap stocks have the potential to grow faster than the higher-market cap ones. Though it is a long-term strategy, the gains in them are much more than those of the higher-market cap stocks. This increases your gains.

Second, it reduces the sector concentration. While  financial services (37 percent) and IT (18 percent) account for more than half of the index (56 percent) weight in the Nifty, those two have only 32 percent weight in the equal weight index. So, an equal weight index is more diversified than the Nifty. Higher diversification also implies lower risk. Third, an equal weight index tends to outperform Nifty 50 during broad based market rallies.

However, equal weight index funds are likely to underperform in the narrow and polarized market rallies such as the one seen in the period between 2017 and 2019. For instance, in 2019, Nifty 50 index rose 13.5 percent while Nifty equal weight index rose only 4.3 percent.

How have they fared?

As per a white paper released by NSE in Feb 2021, Nifty equal weight index has outperformed the Nifty 50 Index for 13 out of the last 22 calendar years. The Nifty 50 Equal Weight Index has outperformed the Nifty 50 Index since June 30, 1999, with 15.3 percent CAGR return against 13.5 percent CAGR return for the Nifty 50 Index (as on Jan 31, 2021). The paper also indicates the volatility profile of the Nifty 50 Equal Weight Index is broadly similar to the Nifty 50 Index. The return-risk ratio of the Nifty 50 Equal Weight Index of 0.68 is higher than the return-risk ratio of 0.58 for the Nifty 50 Index since June 30, 1999, since the CAGR returns for the Nifty 50 Equal Weight Index are higher than the Nifty 50 Index and the volatility levels are broadly similar during the period.

Peer schemes

Currently, four schemes follow the equal weight index strategy. Of these, DSP Equal Nifty 50 and Aditya Birla SL Nifty 50 Equal Weight Index follow the Nifty 50 Equal Weight Index as benchmark. The other two schemes, Sundaram Smart NIFTY 100 Equal Weight and Principal Nifty 100 Equal Weight, follow the NIFTY 100 Equal Weight Index.

Though it is said that equal weight index funds have a higher turnover ratio and charge higher expenses than the plain Nifty 50 index funds, it is not true of the above schemes, as the numbers are more or less similar.