Why the Nifty 50 index may not be relevant anymore

India’s ascendancy as an economic powerhouse is reshaping not only its domestic markets but also its standing on the global stage. India is projected to become the third-largest economy by 2027, up from number 10 in 2014. As a fast-growing country with increasing prospects for investing, this article argues against the most popular barometer for India’s stock market performance, the Nifty 50.

What will India look like in 2050?
India is on a trajectory to become the world’s third-largest economy, with an expected nominal GDP of $25 trillion by 2050. This growth mirrors the United States’ economic expansion over the last four decades. Over the last five years, the average size of a larger-cap company has increased by 2x as opposed to 3.5x for mid-and small-cap companies in India. By 2050, this is expected to grow further by 25 times. This will result in an average small-cap company worth over 2 lakh crore. With most of the incremental growth happening in smaller companies, including them in your portfolio becomes essential. How does the Nifty 50 fare going forward?

Small coverage of the market
The Nifty 50, once a barometer for India’s economic health, now covers just 51% of India’s listed market. When the Nifty 50 was formed in the early 1990s - India had a handful of large companies, hence Nifty 50 made sense back then. In fact, the Nifty 50 used to cover close to 60% of the market 10 years ago. Its importance has fallen and will continue to fall to sub-50%.

Hence, the Nifty 50 only gives you exposure to roughly half the Indian market. This is in stark contrast to broader indices such as the Nifty 500, which encapsulates over 90% of the market capitalisation and offers a comprehensive view of the Indian economic landscape. The Nifty 50’s narrowing coverage indicates its diminishing relevance in representing the broader market, highlighting the necessity for more inclusive indices.

Less sector diversification

Sector diversification is crucial for capturing the multifaceted nature of economic growth. The Nifty 50’s composition, with a higher concentration in fewer sectors, limits its ability to reflect the economy’s sectoral diversity. India has 21 defined sectors, and the Nifty 50 has exposure to only 14. Conversely, the Nifty 500 spans 21 sectors, offering a more balanced and diversified exposure. This extensive diversification is imperative for understanding the nuances of India’s economic expansion and the emerging sectors driving this growth.

Betting on just the top 10 stocks
The concentration risk in the Nifty 50 is evident, with the top 10 stocks accounting for 58.4% of its composition. This contrasts sharply with the Nifty 500, where the top 10 stocks represent 37.4%, illustrating a more balanced approach. This heavy reliance on a few stocks exposes the Nifty 50 to specific sectoral shocks and misses the broader market dynamics captured by more diversified indices.

Performance and risk of more broad-based indices

Performance and risk are pivotal in assessing the efficacy of market indices. The Nifty 500 has historically outperformed the Nifty 50, growing 30x compared to 23x for the latter, since June 1999 (when the index was formed). Moreover, the Nifty 500 has achieved this with slightly lower risk, underscoring the benefits of diversification. Despite having exposure to riskier segments like mid and small-cap - broader indices have more stock and sector diversification, making it less risky than the Nifty 50. Broader indices not only give better returns but lower risk to investors.

Conclusion

As India marches towards its ambitious 2050 goals, the inadequacies of the Nifty 50 as a sole market barometer become increasingly apparent. Broader indices such as the Nifty 500’s broader coverage, sectoral diversity, balanced stock distribution, and superior performance metrics position it as a more relevant and effective index for capturing India’s evolving economic narrative. For investors, policymakers, and market analysts, the shift towards such comprehensive indices is essential to reflect India’s growth trajectory and investment potential.

(The writer is Head - Passive Funds Business, Motilal Oswal AMC)