Hindenburg Effect: Nifty Next 50 and what it means for its investors

A free float represents shares of companies that are held and traded on exchanges by public shareholders. It does not include the shares held by the promoters of such companies.

The Adani Group’s troubles began after a report released by Hindenburg late on January 24 claimed that several shareholders of Adani Group companies were offshore shell companies and funds linked to the group itself. The group has denied the allegations.

As it stands, there has been no revision in the free float of Adani Group shares by the domestic exchanges. Index funds and Exchange Traded Funds (ETFs) tracking the Nifty Next 50 index have shown a sharp correction in the past two weeks. The index itself is down 7.4%. Reason: Shares of Adani Group, which has 14% weightage in the index, came under heavy selling pressure after the Hindenburg report.

Adani Group’s weighting in the Nifty Next 50 index also increased after it acquired Ambuja Cements and ACC last year, which are also part of the index.

The Nifty Next 50 index is gaining popularity among investors as it is seen as an incubator for companies that can potentially turn into blue chip stocks and get included in the Nifty 50 index. In the process, such companies can generate strong returns for investors. There are 21 schemes in Index Funds and ETFs that track the Nifty Next 50 Index. Of these, 14 were launched in the last four years. As on 31st December, these funds were managed by 12,251 crore investor wealth.

past performance

Five stocks of the Adani Group are listed in the Nifty Next 50 Index. These are Adani Total Gas, Adani Transmission, Adani Green Energy, Ambuja Cements and ACC.

To be sure, the fall in Adani Group shares and its impact on the Nifty Next 50 index is a recent phenomenon. However in the longer term, the Nifty Next 50 index has been under-performed by many other stocks. These include recently listed companies like Zomato, Paytm Money and Nykaa. Zomato’s share price has fallen by around 35% in the last one year. Nykaa is down 38%, while Paytm is down 24%.

The Nifty Next 50 index is viewed as a catchment area for stocks that can potentially outperform the Nifty 50. While some of them do transition and turn from large caps to mega caps, many stocks lose their way and even get busted out. , Nifty Next also has some stocks dropped by Nifty 50 and these may underperform more during challenging market conditions.

For example, after performing poorly for several years, Bharti Infratel (now Indus Towers) was moved out of the Nifty 50 in August 2020 and moved to the Nifty Next 50 index. The stock continues to underperform. In the last one year, its share price has declined by another 32%.

This is the reason why Nifty Next 50 Index is more volatile than Nifty 50. Its standard deviation for the one-year period stood at 19.7 as compared to a standard deviation of 17 for the Nifty 50.

Market experts say that only investors with a high volatility tolerance should invest heavily in the Nifty Next 50 index, otherwise an asset-allocation approach is advised.

“Companies that are part of the Nifty 50 account for more than 50% of India’s total market capitalization, while the Nifty Next 50 index accounts for 12-15%. An investor can follow an asset allocation mix on similar lines to invest in these two indices, said Anish Teli, founder, QED Capital Advisors.

He added that investors can also take a look at the stocks that are part of the index (disclosed in index factsheets) and evaluate whether they are comfortable investing in such stocks.

group risk

It is not unusual for an occupational group to have a higher weighting in domestic indices. For example, Tata group companies have an 8.5% weighting in the Nifty 50 index, in which five Tata group companies are part of the index.

“For India, diversification at the group level is as important as diversification at the security level. For that, we need a robust mechanism to define and track group relationships. Global index providers collect this data, but it is not always accurate, said Shivnath Ramachandran, director of capital markets policy at the CFA Institute.

Advisors say that instead of focusing on the group risk, investors should check whether they are comfortable with the strategy being followed by the index. By design, a regular index will not be evaluation-aware. Stocks with increasing market capitalization will see an increase in their weightage in the index, irrespective of their valuations.

This is exactly what happened in the case of Adani Group shares. Adani Green Energy and Adani Total Gas trade at trailing 12-month price-to-earnings (PE) of over 700 times, while Adani Transmission trades at a PE multiple of over 400 times. Because of these high valuations, actively managed schemes largely wiped out Adani Group shares, but were included in the regular indices.

“Here, factor-based indices can be considered. A factor-based index may shortlist 20-30 top companies (in terms of market capitalization) that are more suited to the risk-profile of the investor. For example, the Nifty Low Volatility Index is useful for investors looking for less volatile Nifty companies. Nifty Value Index provides exposure to companies that are trading at low valuation multiples,” said Kavita Menon, Founder, Probitus Wealth.

Sticking to Index Funds?

When it comes to the large cap segment of the market, actively managed funds have found it difficult to outperform the large cap index in the past. In the mid- and small-cap segment, actively managed funds have shown more instances of outperformance than their benchmark indices. Therefore, index investing remains a strong use-case, especially in the large cap segment of the Indian markets.

According to Vishal Dhawan, founder and chief financial planner at Plan Ahead Wealth Advisors, the strength of index investing over actively managed funds is that it removes individual biases. “For example, if a stock or group of stocks continues to decline, they will eventually be kicked out of the index. However, investors may hold the stock in the hope of a recovery, which may or may not happen.”

Anubhav Srivastava, partner and senior fund manager at Infinity Alternatives, shares the same view. “An index has a self-correcting mechanism. Stocks that improve slowly are weighted less in the index. Eventually, if a stock falls significantly in its value, there is a rebalancing of the index at regular intervals on the exclusion of such stocks and the inclusion of new stocks,” he said.

An index may go through temporary periods of volatility when a heavyweight stock or group of stocks comes under pressure. But, remember that indices are not fixed; Their composition keeps changing and the consistently poor performers are weeded out over time. The Nifty Next 50 Index is still a narrow index as it represents 12-15% of the total market capitalization, which makes it more sensitive to market volatility. Investors looking at index-based investing can consider a broad-based index such as the Nifty 50 Index or the Nifty 500 Index for greater diversification.

And if you’re not comfortable with a regular index, evaluate your investment strategy and consider a factor-based index.