A staple across financial papers and news about stock markets in India, the term “NIFTY 50” is ubiquitous in its presence. However, for novice investors and those who are uninitiated into the world of finance, NIFTY 50 could come across as just another finance jargon. Below is a breakdown of its significance and ways to start investing in NIFTY 50 stocks.
What is NIFTY 50?
The NIFTY 50 is an index of the country’s top 50 companies by market capitalization that are listed on the National Stock Exchange (NSE). It is one of the two most referenced barometers used by investors to track how the “stock market is doing”. The other is the Sensex – a similar index of 30 stocks managed by the Bombay Stock Exchange (BSE).
Even though there are 1,300 stocks listed on the NSE, when someone says “the market was up today”, they usually mean the NIFTY 50 index was up. This further means the weighted average performance of those 50 stocks was up. For foreign investors tracking the Indian markets, their first reference point is NIFTY movement and their first few investments in India are usually in NIFTY stocks.
History of the NIFTY 50
Back in the 1960s and 1970s, NIFTY 50 referred to the fifty most popular large cap stocks on the New York Stock Exchange. These stocks were regarded as sure-shot quality buys or blue-chip stocks that were best-in-class and traded at high valuations. Companies such as Coca-Cola, Xerox and IBM are examples of the NIFTY 50 stocks that investors didn’t need to think twice about before buying. Then, in 1996, the NIFTY 50 took on additional meaning when the NIFTY 50 Index appeared on the National Stock Exchange of India and became a staple feature of the Indian stock market.
How are the NIFTY 50 Stocks Chosen?
Most NIFTY 50 companies exhibit a strong balance sheet, robust growth numbers and an expansive global footprint. To put this in perspective, some of the companies in the NIFTY 50 Index are Infosys, Reliance Industries, HDFC Bank, ITC, Asian Paints, etc.
The NSE ranks companies by free-float market capitalization (free float essentially means shares available for the general public to buy and are not locked in). Then picks the top 50 to be part of the index. Apart from that, stocks should also fulfill the following criteria:
- Liquidity, i.e. have sufficient traded volume using a more detailed criteria.
- Should be available in the futures and options (F&O) segment to trade
- Listed for at least six months (or if it just had an IPO, then listed for at least one month)
This list is reviewed every six months when companies are removed and added to the index. The NSE gives the general public four weeks notice of the changes to be made. This is important for many baskets and financial products that are built around owning NIFTY stocks so they can start rejigging their portfolio.
In fact, studies have shown that when a stock is added to the index, in the run up to the inclusion, its stock price actually moves up just on the news of its inclusion as many global funds, ETFs have to add those stocks to the portfolio. The reverse is true when a stock leaves the index. Long term, of course, the impact of these movements is limited and the stock moves based on the merits of its own fundamentals.
What this implies is that the NIFTY is frequently churning out the “losers” – 20 of the 50 stocks that were part of the NIFTY in 2010 are no longer in the index – this means 40% of the index has changed in just 10 years.
What are the Pros and Cons of Investing in the NIFTY 50?
Just these 50 stocks represent 65% of the total market capitalization of all the companies listed on the NSE. In other words, say you added up the market caps of all the 1,300 companies on the NSE – the 50 NIFTY companies would constitute 65% of this total and the balance 1250 companies total upto 35%. Even of all the trades done on the NSE, about 50% are in just these 50 stocks. Therefore even liquidity in the market is highly concentrated to those 50 stocks.
Thus, for any investor who uses the NIFTY 50 index as a guide, it is a useful starting point for investing in the market because a small set of stocks gives you maximum exposure to the entire market.
One of the main reasons why it is considered to be a reliable indicator of stock market performance is because it includes companies from across 14 different sectors in the country.
However, the main concern is that there is a lot of concentration even within the NIFTY 50.
The top 5 sectors in the index today are financial services, information technology, oil and gas, FMCG, and automobiles. Over the years, the index has become more concentrated – in 2010, the top 5 sectors represented 60% of the NIFTY stocks. Today, that number is approximately 80%. Just like with the churn in stocks, the churn in sectors is also heavy. Today, 35% of the index is composed of financial services stocks – banks, NBFCs, etc. In 2010, this ratio was only 15%.
Having said that, even within those 50 stocks, there is a lot of concentration at a stock level – the top 5 stocks of the NIFTY represent 40% of the weight of the NIFTY.
How To Invest in NIFTY 50 Stocks?
Once you have made a final decision to invest in NIFTY 50, you can explore one of the two ways to go about investing.
1. Derivative Contracts
Investors can trade in NIFTY 50 stocks through derivative contracts such as Futures and Options (F&O). These contracts use the index as an underlying asset, meaning that the price movements and fluctuations are linked to that of the NIFTY Index.
In essence, (F&O) are derivative contracts that allow a participant in the market to purchase and sell a stock or index at a specific price and/or on a future date. Although NIFTY derivatives are considered one of the best ways to trade, they aren’t for everyone, especially not for novice investors. This is because it is more of a short-term strategy as contracts expire in three months. Also, due to the high element of speculation, the F&O segment is dominated by hedgers and speculators who have a greater risk appetite and are more adept at monitoring market performance.
2. Index Mutual Funds and Exchange Traded Funds (ETF)
For those of you looking to invest with a long-term perspective in mind and lower risk involved, investing in NIFTY via index mutual funds or an ETF is the best option for you. These are a type of mutual fund with a portfolio comprising stocks, bonds, indices, currencies, etc. and are created to match/track the components of a market index such as the NIFTY.
These funds have the same portfolio of stocks that feature in the NIFTY index, thus, allowing you to be on the receiving end of a host of benefits.
- Low-cost Investment: Investors don’t have to put in large sums of money because index funds essentially pool money from several investors. Most mutual fund companies will allow you to invest amounts as small as Rs 500 a month via SIP plans, and through this, you can become a part-owner of all the 50 stocks of NIFTY 50 in exactly the same proportion as the index.
- Lower Total Expense Ratio (TER): This is the fee percentage every mutual fund generally charges on the overall investment in order to run the business. TER is low here because index mutual funds are passive funds and are not bought and sold frequently at high volumes like active funds are.
- Less Tracking and Monitoring: Since these index funds are essentially a replication of the NIFTY 50 index, fund managers don’t need support from a large team of analysts and market researchers. Decisions about which stocks to buy and when to buy and sell can be made more easily because there is no active buying or selling of stocks in high volumes.
- Great First Investment: Buying the NIFTY as an ETF is a great starting point to your exposure to equities. Given how concentrated the market is, it allows you exposure to a large chunk of the market using a low cost product. On top of this, you can layer on smaller companies, sectors and others to gain exposure based on your conviction and comfort level.
Bottom Line
It is, of course, important to remember that the index is nothing but a collection of stocks and equities in general can be volatile in the short term. Over the long term, investing in the NIFTY 50 Index presents a great gateway into the stock market and is a good opportunity to create wealth.
Since inception, the index has compounded at 11% over the last 27 years. INR 1,000 invested in 1996 is up to INT 17,000 today. The exposure it provides to the country’s top-most and best-performing companies across sectors makes it an investment avenue worth exploring.
