This is another post from the Suggest a Topic page, and today we are going to look at the performance of some of the leading indices in India – their performance, as well as how they are constructed.
The post was triggered by the idea to see if one type of index is better than another, and if it is harder to beat one type of index than another.
My take on both of these questions is no, and here’s why.
For the first question – that of one index being better than another – most modern Indices are constructed using very similar methodology, and certainly all leading indices in India are constructed using more or less the same methodology, and that’s the free float market capitalization method.
So, there is not much by way of index construction that sets one apart from the other. But you will be surprised to know that one of the most popular indices in the world – the Dow Jones Industrial Average is not built using this modern method, and instead is a price weighted index.
This means that the price of the stocks determine how much weight it holds in the index rather than the market capitalization of the stock!
Then, the constituents of the index are determined by the editors of WSJ, and they have discretion to choose and leave out stocks!
Doesn’t this sound all too flawed?
But there is a great Stanford paper that critically examines the index against data from the past and comes up with astonishing results. In the paper the researchers find that even if the DJIA was constructed using some of the more modern methods the results wouldn’t be much different.
I have a full post on this subject here called Mythbusting the Dow, and I definitely recommend it.
The second question is if one type of index is harder to beat than another, and I don’t see how that can be possible.
I can see random walkers say that passive investing is always better than active investing, and while I don’t subscribe to that view, I can certainly see why they say that.
But on what basis do you say that one index is harder to beat than another? I fail to see the sense in that.
Now, let’s look at the numbers, and see what that show us. For this exercise I have taken all the major Indices based on the Sensex and Nifty, and looked at their returns for 4 periods.
1. Year To Date.
2. 3 Year till Jan 2011
3. 5 Year till Jan 2011
4. 10 Year till Jan 2011.
I took calendar years so that I can update this information easily later on, and compare it across other years.
Here are the results of that exercise.
|3 Year Till Jan 2011
|5 Years Till Jan 2011
|10 Years till Jan 2011
This is great data and shows that the performance of large caps has been much better than that of mid and small caps, and that’s mainly attributable to the fact that when the market goes down, the small and mid caps go down a lot more than the large caps, but they don’t bounce back with that great a vengeance.
You can observe that by going across the 3 year return column and seeing how much bigger the negative numbers are at the bottom compared to the top where the indices based on large caps are.
To me, that’s the single most important thing that emerges from this comparison – large caps have done better than small and mid caps in the past and if I were to go the index route, I would certainly prefer to own indexes on large caps or broad based indices rather than bet on small and mid cap stocks.
This is not only true because of the performance, but also because of the generally better corporate governance in large caps, increased liquidity, and the fact that most of our market is concentrated in a few very large companies.
So, the way I would approach this is to select a universe of stocks that I am interested in investing and then choose a low cost, high volume index provider on that universe.
Also, I didn’t see a list of consolidated indices and the explanation of their methodology, so I compiled one myself with data from NSE and BSE, and this will give you a snapshot on understanding what the various indices are and how they are constructed.
|Number of shares
|This contains the 30 largest Indian companies on the basis of their free float market capitalization.
|S&P CNX Nifty
|This contains 50 of the largest Indian companies belonging to 23 sectors.
|CNX Nifty Junior
|The next rung of liquid securities after S&P CNX Nifty is the CNX Nifty Junior. It may be useful to think of the S&P CNX Nifty and the CNX Nifty Junior as making up the 100 most liquid stocks in India.
|S&P CNX 100
|CNX 100 index would comprise of the securities, which are constituents of S&P CNX Nifty, and CNX Nifty Junior
|S&P CNX DEFTY
|S&P CNX Defty is S&P CNX Nifty, measured in dollars.
|S&P CNX 500
|The S&P CNX 500 is Indiaâ€™s first broad based benchmark of the Indian capital market. The S&P CNX 500 represents about 94.92% of the Free Float Market Capitalization and about 91.68% of the total turnover on the NSE as on June 30, 2011.
|A broad-based index, the BSE-100 was formerly known as the BSE National index.Â This Index has 1983-84 as the base year and was launched in 1989.Â In line with the shift of the BSE Indices to the globally accepted Free-Float methodology, BSE-100 was shifted to Free-Float methodology effective from April 5, 2004.Â The method of computation of Free-Float index and determination of free-float factors is similar to the methodology for SENSEX.
|The equity shares of 200 selected companies from the specified and non-specified lists of BSE were considered for inclusion in the sample for `BSE-200′. The selection of companies was primarily been done on the basis of current market capitalization of the listed scrips. Moreover, the market activity of the companies as reflected by the volumes of turnover and certain fundamental factors were considered for the final selection of the 200 companies.
|BSE-500 index represents nearly 93% of the total market capitalization on BSE. BSE-500 covers all 20 major industries of the economy. In line with other BSE indices, effective August 16, 2005 calculation methodology was shifted to the free-float methodology.
|The general guidelines for selection of constituents in BSE Mid-Cap & BSE Small-Cap Index are as follows:Trading Frequency:
1. The scrip should have been traded on 60% of the trading days in the last three months
2. Eligible universe shall comprise of companies aggregating 98.5% of average market capitalization
3. This list shall be categorized under large-cap, mid-cap and small-cap segment based on 80%-15%-5% market capitalization coverage respectively
4. BSE Mid-Cap Index shall comprise of scrips that gives market capitalization coverage between 80% & 95% from the list derived as per point no.3 above
5. BSE Small-Cap Index shall comprise of scrips that gives market capitalization coverage between 95% & 100% from the list derived as per pont no.3 above
6. Quarterly review of these indices shall be carried out as per the above criteria subject to a buffer of 3%
|BSE Small Cap
|Nifty Midcap 50
|The constituents and the criteria for the selection judge the effectiveness of the index. Selection of the index set is, inter alia, based on the following criteria:Stocks with average market capitalization ranging from Rs.1000 Crore to Rs.5000 Crore at the time of selection.
Stocks which are not part of the derivatives segment are excluded.
Stocks which are forming part of the S&P CNX NIFTY index are excluded.
|The criteria for the CNX Smallcap Index include the following:
As always, comments and questions welcome!