How critical is a benchmark index towards influencing broad market sentiments? While we know that Nifty 50 and Sensex the two popular benchmark indices do not fully represent all the listed stocks, they are the closest we have in terms of reflecting the mood or direction of the market in general. A lot of it is because of the large trading interest in the F&O segment which closely tracks the index spot. And a lot of that is also thanks to the index management. Let us understand this, taking Nifty 50 as an example.
What is Nifty 50
According to the NSE website, the Nifty 50 Index represents about 56% of the free float market capitalization of the stocks listed on NSE as on March 28, 2024. To get a sense of the size of what Nifty 50 represents, the total traded value of Nifty 50 index constituents for the last six months ending March 2024 is approximately 28% of the traded value of all stocks on the NSE. Impact cost of the Nifty 50 for a portfolio size of Rs.50 lakhs is 0.02% for the month March 2024. Nifty 50 The index represents 50 companies selected from the universe of Nifty 100 based on free float market capitalisation and liquid companies having average impact cost of 0.50% or less for 90% of the observations for a basket size of Rs. 10 Crores. The Index has been trading since April 1996 and is well suited for benchmarking, index funds and index-based derivatives. The Nifty 50 is owned and managed by NSE Indices Limited (formerly known as India Index Services and Products Limited-IISL), India’s first specialized company focused on an index as a core product.
Review frequency: The review of Nifty 50 is undertaken semi-annually based on data for six months ending January and July. The replacement of stocks in Nifty 50 (if any) is implemented from the last trading day of March and September. Additional index reconstitution may be undertaken in case any of the index constituent undergoes merger, demerger, delisting, specific cases of capital restructuring etc., in case any of the index constituent is moved to BZ series, if trading permission of any of the index constituent is withdrawn from F&O segment, if a security is suspended for trading from Capital Market for any reason and in case of any adverse regulatory findings or orders issued against any of the index constituent that necessitates removal of such stock from the index. In case of a capital restructuring or voluntary delisting, equity shareholders’ approval is considered as a trigger to initiate the replacement of such stock from the index through additional index reconstitution. For all other cases, replacements will be initiated based on notifications issued by the Exchange. Further, additional index reconstitution may be undertaken to screen to continued eligibility of an index constituent that may have undergone corporate action involving demerger in accordance with the guidelines prescribed under a separate section ‘Corporate actions involving demerger/ spin-off’ of this document.
Eligible Securities: Constituents of Nifty 100 index that are available for trading in NSE’s Futures and Options segment are eligible for inclusion in the Nifty 50 index. The latest composition of Nifty 100 including most recent changes whether announced or yet to be announced shall be considered eligible subject to availability of trading in NSE’s Futures and Options segment in such stocks.
Liquidity: For inclusion in the index, the security should have traded at an average impact cost of 0.50 % or less during the last six months for 90% of the observations for a portfolio of Rs. 10 crores. Impact cost is the cost of executing a transaction in a security in proportion to its index weight, measured by market capitalization at any point in time. This is the percentage mark-up suffered while buying/selling the desired quantity of a security compared to its ideal price — (best buy + best sell)/2.
As part of the semi-annual reconstitution of the index, a maximum of 10% of the number of companies in the index (i.e. five companies) may be added in a calendar year. Where the committee considers that the number of changes at the first semi-annual rebalance might restrain the second semi-annual rebalance, it retains the right to reduce the number of constituent changes at the first review in reverse order of the free-float capitalisation. In other words, the Limit on total number of changes: largest eligible company will be added, and the smallest company removed, and then the next largest added and next smallest removed, and so on until the committee deems that the appropriate number of changes have been made. At the second semi-annual rebalance, the same principle applies, however once a total of five companies have been added to the index across the two semi-annual reviews, no further additions (or deletions) will be made. However, the limit of maximum 10% change shall not be applicable for any exclusion of a company due to it not meeting the eligibility criteria on account of factors such as non-availability of F&O, higher impact cost, lower trading frequency; scheme of arrangements such as merger, demerger, delisting, specific cases of capital restructuring etc.; shifting to BZ series; trading suspension; adverse regulatory findings or orders issued against any of the index constituent as stated earlier, etc.
Impact of index management
The key to maintaining a strong streak is to keep on weeding out weak ones, which gets replaced by stocks that are on the rise. Obviously, there are clear cut guidelines for the same, as outlined above, the fact remains that the systematic inclusion of trending stocks in place of weakening stocks increases the odds of Nifty50 continuing upsides.
This is more evident when we picture that only 12 stocks are present in the Nifty50 index since inception.
| Year | 2023 | 2022 | 2021 | 2020 | 2019 | 2018 | 2017 | 2016 | 2015 | 2014 |
| % of newly added stocks | 2.0 | 4.0 | 2.0 | 8.0 | 4.0 | 8.0 | 12.0 | 6.0 | 8.0 | 4.0 |
| NIFTY Index % Change | 19.5 | 3.2 | 25.7 | 15.1 | 11.7 | 4.5 | 27.6 | 2.7 | -3.9 | 31.5 |
| Avg % Chg of Included Stocks | 44.9 | 56.5 | 24.4 | 32.6 | 16.1 | 5.5 | 41.8 | -1.1 | -8.2 | 40.1 |
| Avg % Chg of Excluded Stocks | – | -22.4 | 20.5 | -21.8 | -29.8 | -3.9 | 13.6 | 72.5 | -40.5 | -8.0 |
The table above shows that in the last 10 years, the included stocks have fared better than the index on an average, ninety percent of the time, while the excluded stocks fared weaker, eighty percent of the time (HDFC was merged with HDFC Bank in 2023). This begs the question, is this a more efficient approach than long-term holding. This is a topic for another time, but there is no disputing the fact that it is a very popular approach across globe as is evident from the amount of money tied to key benchmark indices.
