Should you invest in the 'Nifty 50 Value 20 Index' ETFs?

None of the actively managed funds has been among the best performing diversified equity funds in the past year. Surprisingly, even the traditional index-based funds have failed to make it to the top list. Instead, three tiny exchange-traded funds (ETF), based on the little known Nifty 50 Value 20 Index, are leading the performance charts. These funds have clocked around 17% return even as the Nifty 50 Index gained 11% and the top-performing active large-cap fund delivered 15.5% during this period. In fact, these ETFs are also among the top five performers over the past three years. What exactly are these funds? Will they continue to deliver?

The Nifty 50 Value 20 Index (NV20) comprises the 20 most liquid value bluechips selected from the Nifty 50 universe. Besides the return on capital employed metric, the companies are selected on the basis of price-to-earnings ratio, price-tobook value and dividend yield. Essentially, it comprises companies that offer the most value among the Nifty 50 stocks. This is evident in the average price-to-earnings multiple of the NV20 Index relative to the Nifty 50. While the former currently trades at a PE of 17, the Nifty 50 PE is 29.5.

It appears that the composition of the index—heavily skewed towards some of the best-performing Nifty stocks recently— is responsible for its outperformance. Consider this: the NV20 Index currently holds over 16% in RIL and close to 15% each in Infosys and TCS. These stocks have zoomed over the past year. RIL has gained 45%, while Infosys and TCS have jumped 20% each. Though these stocks feature prominently in the frontline indices as well, they do not enjoy as high weightage as in the NV20 Index. Companies from the IT and energy sectors constitute nearly 75% of the NV20 Index. The traditional indices are more diversified.

N20 index ETFs have outperformed by a wide margin
1 year return (%) for Nifty 50 index is 11.05 and for Large cap funds average is 8.96
Source: NSE, Value Research. Data as on 31 May 2019

Apart from NV20, there are several other ‘smart’ indices that derive strength from a specific factor to build a superior version of the main index. Nifty High Beta 50, Nifty Low Volatility 50, Nifty100 Quality 30 and Nifty Alpha 50 are a few such indices. However, unlike NV20, the portfolios of these indices are well diversified, comprising modest exposure to individual stocks. Most actively managed diversified equity funds take an even lesser exposure to these stocks. The 4-5 stocks that have seen sharp outperformance recently find modest representation in these funds. This is why actively managed large-cap funds and multi-cap funds have lagged far behind the market. “The Nifty 50 Index has outperformed most equity funds as a large chunk of the return has been contributed by a handful of stocks, which find lesser representation among funds,” says Vidya Bala, Head, Mutual Fund Research, FundsIndia.

So, it is not NV20’s value strategy that has led to its sharp outperformance, but its concentrated bets. The polarisation in the frontline index has particularly benefited this index. If the market participation becomes more broad-based, the NV20 Index could start underperforming. Considering the three-year rolling return over the past five years, NV20 has outperformed the Nifty 50 index only 57% of the times. In fact, other smart indices comprising select Nifty 50 stocks, such as Alpha and Low Volatility, and their combinations, have fared better than the NV20 Index over the past five years. Currently, no funds are based on these indices.

Outperformance is owing to skewed exposure to this year's winners
Source: NSE, Value Research. Data as on 31 May 2019

Apart from NV20, there are just two smart index based funds available for investors—Quality 30 and Equal Weight. “There are better indices than the NV20 Index, but there are limited options to choose from,” says Bala. She adds that NV20 Index can at best be a substitute for the average largecap fund in the investor’s portfolio. With the fall in the ability of most large-cap funds to increase their alpha, NV20-based ETFs promise higher return over time.

Rohit Shah, Founder and CEO, Getting You Rich, advises caution: “This index adopts a highly concentrated, focused strategy that may not suit many investors.” Investors must also note the significantly low corpus managed by these funds. With such low asset base, the trading volumes on the exchanges are very poor. Investors will find it difficult to buy and sell units at the desired price. When the volumes are this low, the impact cost of each transaction is very high. “The high impact cost means investors will be forced to buy units at a premium and sell at a discount,” says Shah.