If you are from a typical Indian household, you might have hated your results day during your school days. The reason obviously was being compared to, “Sharmaji ka beta” a class topper. This Sharmaji ka beta was a perfect representation of how an ideal kid should be at that age. Well, in stock market terms we have a market index called “NIFTY50” that depicts similar things as this “Sharmaji ka beta” did in our school. Nifty is used by many investors and fund managers as a means to measure the performance of the Indian capital markets and our economy at large. Read ahead to understand more interesting things about Nifty50.
It was launched on April 22nd, 1996, which means it turned 25 this year! What an amazing journey it has seen from 1,107 on April 22nd, 1996 to a new record high of 15,901.60 on 15th June 2021.
All Nifty indices are managed and owned by NSE Indices Ltd (formerly known as India Index Services & Products Limited-IISL). It is an NSE group company that was set up in May 1998 to develop, construct and maintain indices on Indian equities. NSE Indices Ltd came up with 14 broad market indices that represent large, mid, and small-cap segments listed on NSE efficiently. Below is the structure of the same.
What are the inclusion and exclusion/replacement criteria for Nifty?
Nifty is reviewed semi-annually based on the data for six months ending January and July every year. The exchange will give us a notice about the same four weeks before the date of the change.
To be included in the 50 stocks index, the following criteria must be met:
Since June 26th, 2009, Nifty has been calculated using the Free-float Market Capitalization weighted method. Before that, it was calculated using the full market capitalization-weighted method. So, what brought this change? For that, we first need to understand what free float mcap means. It’s quite simple, free float mcap will include public holding in the company only. This means that the promoter and promoter group holding and any other strategic investments by entities/ promoters (Government, FDI, Employee trust, ADR/GDRs, etc.) are excluded from the total mcap of the company. By excluding these holdings, the index can reflect the true market sentiment better for the 50 stocks and ultimately overall capital market. Hence, the index calculation method was changed to Free-float Market Capitalization weighted method.
Now, let’s have a look at how Nifty is calculated in 3 simple steps :
Index value = (Current Market Value (CMV)/Base Market Capital) * Base value
Step 1: Calculation of CMVCMV is nothing but the sum of all 50 stocks’ free-float weighted mcap.
Step 2: Divide CMV by Base market capital
For Nifty50, the base date is November 3rd, 1995. Hence, the base capital is the closing mcap of the index as of this date which was Rs.2.06 trillion. This divisor is adjusted from time to time considering the corporate actions of the constituents as they take place.
Step 3: The result is then multiplied by the Base value.
The base value is the closing price of Nifty as on the base date - November 3rd, 1995, which was 1000. Hence, the result will be multiplied by 1000 to derive the Nifty value.
Nifty is calculated on a real-time basis as the market price of the constituents keeps changing. The closing price of the index is calculated by taking a weighted average of the closing prices of its constituents during the last 30 mins of the trading session.
Why is rebalancing Nifty important?
Over the past 3 decades, India has shifted from manufacturing to services. With the rise of the private sector along with the IT revolution, our market index needed to adapt accordingly and replicate what’s happening in our economy. If you check the table given below for sectoral representation in Nifty50, you will observe that there was no weightage for the IT and telecom sector during its inception. However, now that India has become more technologically evolved with adequate government measures, the IT sector has earned 16.16% weightage whereas the telecom sector enjoys 1.92% weightage in the index as of May 2021. Financial services still have the highest weightage in the index, almost twice as during inception.
Interestingly, 13 stocks namely- HDFC Bank, RIL, HDFC, ITC, HUL, L&T, SBI, Tata Motors, Dr. Reddy’s Labs, Tata Steel, Grasim, Hero, and Hindalco have been a part of the index’s journey since its inception (Source: CNBCTV18) Back in 1996, the State Bank of India (SBI) had the highest weightage at nearly 8.6%, followed by Tata Motors at 6.9%. As of May 2021, RIL (10.36%), HDFC Bank (9.79%), and Infosys (7.66%) held the highest weightage in Nifty50.
As a part of its semi-annual review, stocks that have fallen in terms of market cap criteria would be replaced with emerging stocks fitting into eligibility criteria mentioned above thereby increasing the exposure of the index to emerging stocks and sectors. This way Nifty has reflected the changing trends in the equity market with increasing/ introducing representation of emerging sectors in the economy.