At a time when Sensex and Nifty are running crazy, are you too going nuts over your portfolio like most other retail investors? Yes, we can see it in your expression. Well, if you do not want to be left alone with a bunch of non-performing stocks in times ahead, read on to know how your money can work smarter in the stock market.
The real index!
The word ‘index’ refers to the performance of the stock market. In other words, it is the indices that reflect the investor sentiment and the state of the country’s economy. If this is true, then why is it that most of the retail investors are sitting on losses for years or why is it that people are reluctant to invest even when the indices are touching new highs almost every day? This raises a question in our mind: Is index the real indicator of sentiments?
Over the past few months, we spoke to over 1,000 retail investors to understand what constitutes their understanding of the index. And the information we gathered from the survey is quite fascinating.
Strangely, most of the retail clients we met have invested in stocks which gained media traction rather than those which were part of any known index.
There were some who said they felt happy just seeing the indices soaring high, irrespective of their portfolio doing good or bad. Interestingly, the majority of the retailers believe that the stocks which do not form a part of the index (especially mid and small caps) are capable of giving better performance. The majority of them felt that they could beat the index, despite the fact their portfolio was actually underperforming.
Let’s first understand a few basics about the Index and its formation. Across the globe, indices have been built over market capitalisation or sectoral representation. India too is no exception with the major indices being built based on market capitalisation. We would like to highlight a few examples wherein indices in India have fallen short.
During 2009-2011, owing to higher infrastructural projects in North and Eastern India, cement companies like Shree Cements, JK Lakshmi and Jaiprakash (based out of north and eastern India)were outperforming, while companies of other regions like ACC, Ambuja Cements and India Cements which were constituents of the leading indices failed to provide any impetus to the index. It is due to this variation in demand with respect to different regions that the index failed to highlight the true potential of the cement sector vis-a-vis the other sectors that were forming part of the index.
In another example, last year Infosys, which is a major index heavyweight, was having turbulent times, whereas companies like Persistent Systems, Hexaware were giving a bullish picture on the IT sector. As major indices are based on capitalisation methods, they failed to highlight the real performance or potential of the IT sector.
The point of concern here however is not the performance potential of any particular company. The problem lies in the style of creating an index. In India, we follow the market capitalisation way of managing an index.
According to a case study conducted by researchers of ‘The Cass Business School’, the problem with the approach of market capitalisation stems from some stocks being overvalued and others being undervalued at any given point in time. A capitalisation index gives too much weight to the overvalued components and too little to the undervalued ones. That is the crux of the problem.
In fact, for decades now, most of the indices have been compiled by weighing stocks based on their total capitalisation. However, the primary factor or the very basic premises of investing goes completely missing in the process. In simple terms, as a stock gets more expensive in terms of valuation, its index weighting can grow significantly. This makes the index’s over valued more vulnerable as sell-offs in those index heavyweights that have registered significant gains become inevitable.
There are two other ways of weighing an index: One is based on price and the other on dividend payments. However, every index has its limitations and perhaps it is this vacuum that has categorically made way for a lot of alternative ways of indexing.
In the very first place, it is important to identify the various other alternative ways of building an index, and how the index would perform going forward? However, it is also important to understand that as the new index is weighted using different methods, the returns it gives could be different from that of the traditional capitalisation weighted indices.
In the same ‘The Cass Business School’ case study, the researchers examined how 13 alternative index methodologies would have performed for the 1,000 largest US stocks from 1968 to 2011. It resulted in all of the 13 alternative indexes producing higher returns than the theoretical market-cap-based index the researchers had created. While the market-cap index generated a 9.4 percent annualised return over the full period, the other indices delivered something between 9.8 percent and 11.4 percent. The study evidently proved that a market capitalisation index would not give the right picture, rather generate lower returns as it leaves out many stocks with higher potential.
It is this flaw in the traditional capitalisation methodology that has inspired us in creating an index that would seek to address many discrepancies.
Why My Own-20?
While there is an instant need of creating a new index, the first and foremost question that would haunt the investors is: What is so unique about MyOwn-20? MYOWN-20 is a combination of various weighing techniques. To start with, it gives equal weightage to all the constituents; however, going forward it would make alterations based on the different analytical parameters set by us. But the moot question is what is unique about this MyOwn-20?
It can be described in a very simple manner. In cricket a peddle sweep is a common shot played by a cricketer. However, the way Sachin Tendulkar plays the same peddle sweep in his own style, improvisation on the technique, makes his sweep a unique one. Similarly, the improvisations we do after putting equal weightage constitute the uniqueness of MyOwn-20. In a nutshell, a company would form a part of our index only on the basis of merit and not because of its market cap.
Weightage – Will That Change
As stated earlier, we allot equal weightage to each stock, with the base being 1,000 and the base date, January 1, 2015. However, as a practice, we would be regularly evaluating the performance of the stocks. Accordingly, the weightage in the index would change and hence the contribution of each company would also change. Reviews would be done on a monthly basis.
While in Index management we have focused on why we need an equal weight index to maintain a portfolio. Now let’s move to the next leg of focusing on the objectives of the Index, Benchmark to compare, and the detailed process of managing the index.
Objectives of Index
The primary objective of our index creation is to bring out the actual worth of Indian companies to the investors. Our index would bring out the best performing company from a sector and not the one with a high market capitalisation but meek performance. As stated earlier, there would be reviews on the performance on a month on month (MoM) basis, eventually identifying a stock of the month and a sector of the month.
We are opinion that one should only focus on what kind of returns an individual expects from the markets. And hence benchmarking is one factor that hardly matters to us. To explain it in a simple manner, here is one story. There was a place where only a few rich investors used to stay. One day a new person visited that place and asked one of those rich investors. He asked you are a great investor, did you manage to beat the index. He answered, I really do not know, but I have earned that much that I can afford to stay here. Hence when it comes to your expectations, benchmarking hardly helps. However, in a scenario of cutthroat competition, we have to benchmark our index to Show a relative performance.
Tracking an index is important, involving a lot of factors like managing the different constituents. Besides a monthly review of our index companies, tracking would be done on daily basis as well. We would be providing a daily open, high, low and close. Events like, bonus, split, dividends, mergers, de-mergers, and even spin-off of divisions would also be taken care of as and when they occur.