With its strong correlation to the Nifty 50, does the Total Market Index provide diversification?

Though the concept is definitely not new, it is indeed the first time that India has established an index comprising all market segments. Nifty 500 was doing a decent job till now to encompass large, mid and small-cap stocks. But there was no representation of microcap stocks. So, this new index fills that gap.

But to further assess the actual uniqueness, we must have a look under the hood.

A glance of the NSE factsheet shows that the new Total Market Index will be highly correlated with the existing Nifty 50 index. As per the data provided by the NSE, the correlation stands at an extremely high 0.98. This means that the returns of Nifty 750 and that of Nifty 50 are expected to be quite similar, most of the times.

The reason for this is that the new index will be constituted via market cap-based stock weightages. So, the larger companies in the index will get higher weights assigned to them.

How much will then be the weight of Nifty 50 or Nifty 100 companies in TMI 750?

My guess is that it will range from 75-85 percent. So, if you thought you would get equal exposure to all market caps, then that’s not happening via the new index. You will not get an equal 25 percent weightage each in large, mid, small and micro-cap stocks via the new TMI 750 index. This is quite similar to the findings of the analysis I did some time back about why Nifty50 + Next50 is not the same as Nifty100.

This also means that stocks of several smaller companies will have negligible weight in the index. So, even though at times microcaps are known to deliver eye-popping returns (of course with high risk), the gains will not translate into any meaningful upside for the new index investors due to the small weights of these microcap stocks.

Also read: Don’t rush to invest in NFOs of new AMCs

So enough of the analysis part. Let’s try to answer the core question now.

Do you need to invest in the Total Market Index?

If you already have index funds that track the Nifty50/Sensex, then, more or less, you may expect similar returns from the new index. So, there isn’t exactly a need for the same. If you also hold other passive instruments such as the Nifty Next 50 index fund, then you already have a reasonable exposure to the top 100 stocks with decent individual weightages. You don’t need another index fund to take exposure from the 101st to 750th stocks, as the weights of these stocks in the Total Market Index won’t be much.

If you have no passive funds in your portfolio, then this new option can still be considered.

A possible alternative can be the Nifty 500 index funds/ETF that provides sufficient diversification via a well-tracked index and also avoids exposure to microcap stocks from 501^st to 750^th ranked companies (stocks that have a market cap below Rs 5000 crore). By the way, if you really are looking for microcap stock exposure, then there is an index just for you. I wrote about it here and my view, in general, is that most people don’t need to invest in high-risk microcap stocks.

The new AMCs are going out of their way to innovate and launch new offerings every few days. This is good for the MF space in India and will push further penetration. But when it comes to your mutual fund portfolio, keep things simple and limit the number of schemes (passive or active) that you invest in.