Broad-market rally sees equal-weight funds outperform indices on returns

During the past one year, some funds in this domain have generated returns of 38-42 per cent. In comparison, the Nifty and Nifty 100 indices have gained less than 34 per cent

The broad-based rally in domestic equities have helped equal-weight funds steal thunder over their underlying market capitalisation-weighted indices.

During the past one year, DSP Equal Nifty 50 Fund, Principal Nifty 100 Equal Weight Fund and Sundaram Smart Nifty 100 Equal Weight Fund have generated returns in the range of 38-42 per cent. In comparison, the Nifty and Nifty 100 indices have gained less than 34 per cent.

An equal weight index assigns equal weightage to all components of the index. On the other hand, in a conventional m-cap weighted index, the weights are decided by the market value of the underlying stock.

To illustrate, the Nifty 100 index has 100 underlying stocks. An equal weight index will assign a one per cent weight to all the 100 stocks. The m-cap weighted index considers free-float market cap of all the stocks. The weightage of individual stock is its free-float market cap as a percentage of cumulative free-float market cap.

Index funds and exchange traded funds (ETFs) tracking these indices try to mimic the returns of the underlying indices.

Anil Ghelani, head of passive investments at DSP Mutual Fund says that the basic principle of investing is that one should invest in good companies which are leaders in the sectors and secondly portfolio should be well diversified.

“While Nifty 50 meets the first criteria, the index is heavily tilted towards few sectors such as Financials, Oil & Gas and IT. So, this fund invests equally across all the 50 stocks in the Nifty index and broad-based rally in the last one year has helped the fund to deliver better returns,” he says.

DSP Equal Nifty 50 Fund rebalances the portfolio every quarter and has allocation of 2 per cent across the 50 stocks of the index.

Over the last months, most of the bottom 30 stocks of the Nifty 50 index have seen a sharp run, bolstering returns of equal-weight funds.

“While our fund had only 2 per cent exposure in some of the top names of the index, strong performance across the sectors in the index have helped the fund. With strong flows coming from foreign portfolio investors and earnings of the companies also improving across the market capitalization, we believe that broad-based rally is likely to continue in the coming time as well,” says Ghelani.

Since 2018, Indian markets had seen sharp polarization as only dozen-odd stocks were delivering the returns in the benchmark indices. In such times, the returns of equal weight funds tend to lag that of the main indices.

Equal weight funds do well only when there is a broad based rally and underperform when only few stocks drive up the market.

“The kind of volatility we have seen in the last few months have ensured that equal weight indexes have done better as it works on the principals of curtailing the fall. This strategy doesn’t give as much returns when there is a high one-sided rally and historically, we have seen market-cap based investing have worked better compared to equal weight indices,” said Vidya Bala, co-founder of Primeinvestor.in.