RIL's heft adds to fund managers' woes as stock makes up 20% of Sensex

Large-cap MFs risk face risk of losing out on the rally

Reliance Industries (RIL), whose shares soared over 7 per cent on Tuesday, now accounts for close to a tenth of India’s listed market capitalisation (market cap). The Mukesh Ambani-led firm’s market cap is now nearly a fifth of the combined market cap of the 30-share Sensex index.

The stock has more than doubled from its March lows and quadrupled since December 2016, with a weighting of 14 per cent on the Nifty50 index as of July 31. After the latest jump, RIL’s weighting on the Nifty and the Sensex could have crossed a record 15 per cent and 18 per cent, respectively, according to back-of-the-envelope calculations.

RIL had a weighting of 8.77 per cent as of March 23 and nudged past the 10-per cent mark in June. The only other time it had crossed the 10 per cent threshold was in early 2008. The weighting for the Nifty50 components are computed using free-float market cap.

“The recent fundraise, deleveraging of balance sheet, and several initiatives on the digital and consumer side of its businesses have aided the sentiment for rerating of the stock,” said Gautam Duggad, head of research-institutional equities, Motilal Oswal Financial Services.

The run-up in RIL, however, might pose a challenge for fund managers, as active funds aren’t permitted to hold more than 10 per cent in a single stock in a particular scheme. In addition, individual fund houses could have softer limits that prevent buying a stock above certain thresholds, say 5 per cent or 7.5 per cent of the overall scheme holding.

This means that fund managers do not get the opportunity to participate in the stock’s outperformance if its weighting exceeds 10 per cent.

Experts believe that large-cap schemes, which largely have to focus their investments in the top 100 stocks in terms of market value, might bear the brunt of the higher RIL weighting. These schemes might underperform the indices unless market breadth improves and a sizeable number of stocks start to rally. A diversified equity scheme typically invests in 45-60 stocks. 

“Typically, fund managers can generate alpha by taking exposure to outperforming stocks that are not index heavyweights. But in a narrow market, this becomes a challenge, particularly for large-cap funds,” said Harsha Upadhyaya, president and CIO-equity, Kotak Mutual Fund. Fifty-three per cent of Nifty50’s rally from a bottom of 7,610 on March 23 to 11,073 on July 31 was led by five firms — RIL, Infosys, HDFC Bank, TCS, and HDFC.

The top 15 stocks contributed over 75 per cent to the rally. HDFC Bank, till recently, also had a weighting of more than 10 per cent on the Nifty50.

Ironically, the bottom-40 stocks are where fund managers might discover value. “This divergence (in performance) has widened in recent months. Based on the top 10 stocks, the adjusted Nifty value works out to 13,044, while the remaining 40 would lead Nifty to 8,711. 

This indicates Nifty is fairly valued beyond the top 10 names. Long-term risk rewards are better in the next 40 names versus the top 10,” said a recent note by Axis Securities.

Sector concentration has inched up, too, with four sectors — financial services, oil and gas, information technology, and consumer — accounting for over 77 per cent of the weighting on the Nifty50, shows the exchange data.

The pandemic is expected to tip the scales further in favour of companies with higher market share and well-entrenched businesses. This might polarise further.