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Harshil:

On this episode I sit down with head of research at ithought and Co-Fund Manager of COIN, a large cap focused fund by ithoughtPMS. Balaji is an active speaker in public forums including the Tamilnadu Investors Association and a regular columnist at The Hindu.

Balaji, it is great to have you on the show

Balaji:

Thanks for having me as part of your show.

Harshil: 

Let’s start off with how the NIFTY index is structured and how it has sort of gone through its transition. -calculation transition & – weightage changes over a period

Balaji:

Sure, let me structure the conversation into 2 parts

      • Why we need to understand NIFTY index and
      • What benefits we will get by having a good understanding on the composition of structure of the NIFTY itself

To begin with,

NIFTY index is the most widely watched and discussed index in India. NIFTY Index has become a sole torch bearer for gauging the overall performance of the market by lot of retail, HNI and Institutional Investor. Lot of portfolio allocation and valuation driven model is solely based on NIFTY Index itself. It’s very important to understand NIFTY Index deeper level to make appropriate right decision.

If you were to see the brief history of NIFTY – the Index was introduced in 1996 and consists of heavyweight companies by full market capitalization. However, in June 2009, it shifted to the float-adjusted market capitalization-weighted methodology from the complete market capitalization-weighted index. *Stress on highlighted part*. This development was very important for a practitioner who uses the NIFTY past data to analyse. This one development had brought dramatic changes in the NIFTY Stock weightage in a jiffy.

For E.g.: Few stocks have lost significant weight due to these changes. The top 2 big losers are NTPC and ONGC. They put together lost 10.4% weight in NIFTY and few bigger gainer are Infosys, ICICI Bank, LT, HDFC Twins weight increased in the range of 2-4%.

Any analysis done across this time period should keep this development in mind so that their conclusion is fair. So, what happens is, once you replace asset heavy business like ONCG and NTPC to Infosys, and a few Banks – the widely used multiple like PE ratio will change dramatically.

Harshil:

Passive investing is in full force globally and it will take off here as well, but for us as investors how do we look at the quality of the index as a passive product. Or how should an investor view a passive product. Can you talk a bit about how is the current Quality of index? 

Balaji:

NIFTY itself is an Evolving Index. The name of the index remains the same, but the constituents had changed dramatically in last decade +. If you look at last 15 years few interesting observation on NIFTY.

      1. Stocks like HDFC bank, HDFC LTD, TCS, consistently gained prominence in last 15 years
      2. ONGC which had 15% weight during 2004, lost 5.8% during free float transition and currently has only 0.62% weight in the index.
      3. Similarly, NTPC weightage had come down from high of 7.1% to 1.2%.
      4. 23 of NIFTY Index stock during 2004, is not part of current NIFTY Index. Names Like BHEL, Suzlon, PNB Bank, MTNL.
      5. Recent Addition to NIFTY Index – like Nestle, Britannia, Tata Consumer, Shree Cement, HDFC and SBI life, Divis, JSW Steel.

The current index quality in terms of Balance Sheet Strength & Return Ratios like Unlevered ROE is significantly superior.

Most of the stocks are valued at higher multiple due to strong BS and cash flow metrics which pushes up the NIFTY valuation without any fundamental change in the price of the underlying stock.

What I think is that the biggest merit of NIFTY is that the index is a wide representation of few large domestic facing sectors like Financials, Auto, FMCG, and also Exports sector like IT, Pharma and Auto 2W where exports are becoming more prominent.

Most of the big, large winners are tend to eventually be included in this index which enable lot of passive investors also to capture the gains out of these companies. Example: Kotak banks got added during 2010 with weightage of 0.78% and if you see the best NIFTY stock for last decade was Kotak Bank. Even if you check large best performing global index like NASDAQ – the Top 5 stocks – Apple, Amazon, Alphabet, Microsoft, and Facebook did exceedingly well which results in overall performance of the index itself. In a way- NIFTY does an active role like analyst in identifying potential large winners way ahead of time.

The biggest drawback on NIFTY index I would say is at times the index gets very skewed during market tops. If you check banking sector weightage has increased dramatically in last 15 years from 11% to 35%. The good fortune of the index is very heavily reliant on singe sector which is not ideal for conservative forward looking investor who wants very stable performance

The single stock weightage risk in the 2nd biggest risk in NIFTY both Higher and lower. E.g.: HDFC Bank weightage at their peak had weightage of more than 14% in the Benchmark (11% standalone weight and 3% implicit weight in HDFC Ltd). If you see this stock has underperformed sharply in last 12 months due to various reason. Any conservative investor would like to limit single stock exposure probably in single digit as part of risk management. On the contrary – most of large wealth creator of last decade in NIFTY like Kotak Bank had less than 1% weight to begin with. Even today 24 companies in NIFTY have less than 1% weight. In a nutshell – NIFTY index is diversified by name and not by weight. The Top 2 still command 18% weightage in NIFTY which is equal to bottom 25 NIFTY stocks. This shows how much disparity among the NIFTY Stocks itself.

Harshil:

Yes, Balaji that’s absolutely true and not many investors are aware of this disparity so how should an investor go about investing in the index at this current market valuation

Balaji:

      1. Asset allocation model based on NIFTY valuation must keep these changes in perspective to adjust the model outcome. All the recent addition to NIFTY has come from sectors which are generally having higher multiple which results in higher valuation. E.g.: Britannia Industries and Nestle India. Nifty valuation ratios like PE ratio can be reconstructed by using current NIFTY stocks to getter a better perspective on historical valuation.
      2. HDFC group weightage has increased from 3.78 % to 16.36% in last 15 years. Fund which are either overweight or underweight in these 3 stocks has vastly different outcome. Strategic call must be taken by portfolio manager to see that they are not caught off guard.
      3. Index is highly skewed towards Banking. Any deterioration in banking sector will have a telling impact on the index. Sectors which have less correlation vs banking like (FMCG, Pharma, IT and Exports) must find strategic place to prevent portfolio from undue interim volatility.

Harshil:

Now Before I let you go let’s talk a little bit about your fund COIN, and your style of investing and what lies in the future for coin

Balaji:

So, the fundamental principle which is the core of COIN –

Container and Invert – If you check what container did to logistics industry during 1950. The cost of logistics was down 75% due to container which led to large globalization in last 6 to 7 decades. For us NIFTY is the largest and most popular container. By making NIFTY as container – we were able to bring zero fixed fee in our PMS product and only get paid once we perform above our

hurdle rate which is 6% pa. The fund ideal expense on a sustainable basis should be lower than comparable large cap fund by at least 50 %. Any investor who likes to invest in large cap / NIFTY index is the ideal investor who should look at COIN Fund. On top of Container – we apply the principle of Invert by Charlie Munger where we want to first remove the structural weak business from the universe so that our investment is very rewarding with lease amount of stress. The big elimination is we don’t own any government owned companies in COIN Fund –and second, we remove companies with higher debt. Higher debt in BS carries 2 risk – in most case – the financial leverage adds to both higher upside in good market and sharp fall in down market which we want to avoid as it brings higher stress to common investor who really can’t handle higher volatility. Most investor tend to believe they have higher risk appetite but in reality, they have very low appetite which got even reflected during covid crisis where money raising was very difficult, but the prospective return was excellent. Once we removed higher financial leverage companies, we screen their profitability across market cycle let’s say last decade to remove companies with weak operating profitability history so that our universe is full of stocks with good capital allocation tracks record companies with higher ROE and lower or Zero Debt like TCS, Infosys, HDFC Ltd Etc.

Coming to the Level of Concentration:

NIFTY index is a concentrated portfolio. NIFTY index is diversified by name but not by weight. 50% of the Index weight is only 7 Stocks – (RIL, HDFC Bank and Limited, Kotak Bank and ICICI Bank and Infosys and TCS). COIN will be well diversified within NIFTY Stocks. Every single stock will get an adequate representation. Kotak bank which was one of large wealth creator of NIFTY stocks in last decade had only 1% weight during FY 2011. Higher weightage to such potential stock can lead to sustainable and stable wealth creation

Avoiding skewness in portfolio top holding. Good mix of Banks and IT, FMCG and Infra and not like financials heavy NIFTY Index.

Buying well and Buying Slow is the deep routed strategy in COIN – Once the capital is allocated by the investor – buying will happened to those NIFTY stocks where we believe the risk adjusted returns on medium term is good – we allocate capital faster and the balance will be invested over the course of few months to quarter to wait for any potential market dislocation to add position in stocks where the valuation was demand. Buying discipline is key as these companies are well established business with reasonable medium term intrinsic

growth. The only big mistake to avoid is to buy at any price which we want to completely avoid. Just to reflect on this thinking – for our initial investor in COIN Fund – we have invested around 60-65%.

Our aim of COIN Fund is to build a world class stable large cap portfolio with highest quality in terms of ROE and BS Metrics with sharp discipline of buying at right price so that Investors with min 3-5 years’ time frame and who want to build lowest risk equity fund for their retirement or institutions who have mandate only to invest in NIFTY strategy or HNI’s who want superior alternative solutions to fixed assets or Asset allocation fund can allocate capital on continuous basis without bothering about timing the market .

Creating happy investing journey is the ultimate goal so that fruits of equity can be enjoyed without much additional stress.

I have taken enough of your time, thank you so much for coming on the show and sharing your insights, I had a wonderful time having this conversation and I hope to connect with you soon

Thanks, Harshil for giving me this wonderful opportunity to discuss on NIFTY index which is one of my favourite topic to thinks about as large capital is allocated in this index.

Harshil:

If you are someone who is looking to make the most out of investing in nifty get in touch with us at info@ithought.co.in or DM ithoughpms on Linkedin or Twitter.

That’s all we have for this week I hope you really enjoyed this one, do us a favour and follow us on us on your favourite podcast app and maybe even leave us a review and with that we will see you again next time.

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