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Flavours to passive investing

Apart from mainstream indices such as Nifty and Sensex, some of the niche-strategy indices have put a strong foot forward. Here is a primer on some of them and their investment case

Flavours to passive investing

Over the past few years, index investing has started catching investors' fancy. However, most of the investments in the index space are largely confined to the top mainstream indices, including the Nifty 50 and the Sensex. However, in a bid to provide more choices to investors in the passive space, fund companies also offer funds investing in some other indices. Interestingly, some twists in the forms of certain quantitative models and investment strategies were given to the mainstream indices to create these indices.

Only a small number of funds are tracking these indices and managing a pretty modest amount of money. With the aim of checking whether or not these indices have any investment case and the potential to become the mainstream ones, we have analysed the performance of such niche-strategy indices based on the Nifty 100 and the Nifty 50 indices.

  • Equal-weight index: This index comprises the same companies as its parent indices. While the weight of each company in the parent index is based on the free-float capitalisation of companies, each company gets equal allocation in this index. This ensures adequate diversification.
  • Value 20 index: This index has been designed to reflect the behaviour and performance of a diversified portfolio of value companies. It comprises the listed 20 most liquid, value, blue-chip companies. These companies are selected based on various parameters, such as return on capital employed (ROCE), P/E ratio, P/B ratio and the dividend yield.
  • Quality 30 index: This index includes the top 30 companies from Nifty 100 based on their quality scores. The companies are selected based on parameters such as return on equity (ROE), financial leverage and earning (EPS) growth variability.
  • Low volatility 30 index: This index tracks the performance of 30 stocks with the lowest volatility in the mainstream index in the last one year.

So, how have they fared vis-à-vis the parent index? Well, over the last one year, equal-weight indices have trumped all others (see the chart 'Major indices: 1Y trailing returns').

Flavours to passive investing

However, an analysis of rolling returns over a much longer time frame reveals a different picture altogether. The equal-weight indices have not built a compelling investment case, as suggested by their recent performance. On the contrary, the Value 20 Index and the Low Volatility 30 Index have the strongest track record of outperforming their respective parent indices (see the table 'Rolling-returns comparison').

A more in-depth comparison shows that the Low Volatility 30 Index has the best and most consistent performance record (see the graph 'Rolling 5-year return comparison').

Flavours to passive investing

But how did they perform during market crashes? Here again, the Low Volatility 30 Index has proved to be the most resilient in each of the major market falls over the last 10-12 years (see the chart 'Performance during market crashes).

Flavours to passive investing

The outperformance of the low-volatility strategy may be the reason behind the lone ETF tracking this index (ICICI Prudential Nifty Low Vol 30 ETF) being by far the biggest fund amongst all the passive funds tracking strategy indices. In fact, its assets have grown more than fivefold over the past one year from just about Rs 61 crore in April 2020 to over Rs 300 crore as of April 2021.

So, should you invest your passive allocation in this ETF? For that, we need to go beyond just the performance of the index. See the set of numbers collectively titled 'Other metrics'.

Flavours to passive investing

Flavours to passive investing

Flavours to passive investing

As you can see, both at the stock and sector levels, the index offers a more diversified portfolio than the mainstream indices. It is also high on replicability, as suggested by a low tracking error. However, its expenses turn the deal sour. As an important parameter, the cost factor must not be overlooked, particularly in the case of intensely competitive passive products. At a time when most of the mainstream ETFs are available at an expense of just about 7-10 basis points, it seems exorbitant to pay fivefold for this ETF. And if you opt for its recently launched fund-of-fund (FoF) variant, add another 0.63 per cent for the regular plan and 0.13 per cent for the direct plan - the expenses just go through the roof.

So while the NIFTY 100 Low Volatility 30 Index has delivered superior outcomes sustainably, the expenses of the only ETF tracking this index is much higher than the ETFs tracking the mainstream indices. Hence, a lower expense ratio could be a welcome move, which would make this fund more attractive.