A lot of investors think that the Nifty 50 Equal Weight and Nifty 50 Index are the same things. But actually, they are not that similar, we will understand much deeper the difference between the two as we go ahead in the article.
1. How are they Different?
i) Equal Weighted Index:
- An equal-weighted index is a stock market index that invests an equal amount of money in the stock of each company that makes up the index. They remove the market cap bias, giving an equal shot to every company within the index.
- Equal-weighted indexes, in effect, favor smaller companies by giving them the same importance as large-cap firms.
- This means that even the smallest of companies exert more power in an equal-weighted index than it would in one weighted by market capitalization.
ii) Market Cap Weighted Index:
- The Capitalization-Weighted Index (cap-weighted index, CWI) is a type of stock market index in which each component of the index is weighted relative to its total market capitalization.
- The securities are weighted proportionally to their market value: the larger the company, the larger the weight in the portfolio and vice versa.
- An index fund weighted by market capitalization invests more into companies with higher cap than others. Regardless of the overall scale of companies that an index represents – small-cap, mid-cap, or large-cap – the index is stacked heavily in favour of the largest companies in the index.
2. Performance Comparison:
i) Returns and Volatility:
- The Nifty50 Equal Weight Index has outperformed the Nifty 50 Index since June 30, 1999, with a 15.3% CAGR return against 13.5% CAGR return for the Nifty 50 Index.
- From January 31, 2020, to January 29, 2021, the Nifty50 Equal Weight Index returned 21.9% against 15.2% for the Nifty 50 Index
- However, over the last 5 years from January 29, 2016, to January 29, 2021, the Nifty50 Equal Weight Index has underperformed the Nifty 50 Index, returning 11.7% CAGR return against 14.0% CAGR for the Nifty 50 Index.
- The annualized volatility is almost similar for both the indexes and same with the return-risk ratio of both.
Source: NSE Indices. Data as of January 29, 2021. Returns based on TRI values. Benchmark for beta and correlation calculation is the Nifty 50 Index
ii) Calendar Returns:
- The Nifty50 Equal Weight Index has outperformed the Nifty 50 Index in 13 out of the last 22 calendar years from 1999 onward.
- The Nifty50 Equal Weight Index tends to outperform the Nifty 50 Index when there is a broad market rally, as is often the case after a large market decline.
- When the market rally is narrow and led by only a few large names, for example in 2018 and 2019, the Nifty50 Equal Weight Index tends to underperform the Nifty 50 Index.
iii) Beta and Correlation:
- The Nifty50 Equal Weight Index has had beta < 1 over various time horizons using the Nifty 50 Index as a benchmark.
- Since June 30, 1999, the Nifty50 Equal Weight Index has had a beta of 0.93 using the Nifty 50 Index as the benchmark.
- The Nifty50 Equal Weight Index has also exhibited a strong correlation with the Nifty 50 Index over long time horizons, as expected.
- The correlation between the Nifty50 Equal Weight Index and the Nifty 50 Index has been 0.96 over the 10 years from January 31, 2011, to January 29, 2021.
3. Pros & Cons-Equal Weightage Index:
- Equal-weighted indexes are more diversified than market capitalization-weighted indexes.
- In a market-cap-weighted strategy what happens is, you end up owning more of the larger stocks because they have a greater weight in the index. In an equal weight strategy, you diversify it across a broader range of securities and sectors within the index.
- Equal-weighted funds focus on value investing, which is considered by many market analysts and investors to be a superior investing strategy.
- Equal-weighted indexes feature a higher portfolio turnover rate, which means higher total transaction costs, and which can also result in less favourable tax treatment
- They are more vulnerable to sudden, volatile drops in value during a bear market phase (In contrast, market-cap-weighted funds that are more heavily invested in large-cap, blue-chip stocks are likely to be more stable in bear markets.
Keeping all the analysis in mind, the conclusion can be made that these two indexes are almost similar regarding the risk profile and beta correlations. Whereas, you get better diversification on equal-weighted stocks and lower costs when it comes to investing in a market-cap-weighted index. One should consult their financial advisor before investing.