A free float represents the shares of companies that are held and traded on the exchanges by public shareholders. It excludes shares held by promoters of such companies.
Adani Group’s troubles started after a report issued by Hindenburg late on 24 January claimed that many shareholders of Adani Group companies were offshore shell companies and funds tied to the group itself. The conglomerate has refuted the allegations.
As things stand, there has not been any revision of free float of Adani group stocks by the domestic exchanges. Index funds and exchange traded funds (ETFs) tracking the Nifty Next 50 Index have corrected sharply over the last two weeks. The index itself is down by 7.4%. Reason: Adani Group stocks, which accounted for 14% weightage in the index, came under heavy selling pressure after the Hindenburg report.
Adani group’s weight also rose in Nifty Next 50 Index after it acquired Ambuja Cements and ACC last year, which are also part of the index.
Nifty Next 50 Index has been gaining popularity among investors as it is seen as an incubator for companies that can potentially turn into blue chip stocks and get included in the Nifty 50 Index. In the process, such companies can generate robust returns for the investors. There are as many as 21 schemes across index funds and ETFs that track the Nifty Next 50 Index. Of these, 14 were launched in the last four years. As of 31 December, these funds managed ₹12,251 crore worth of investor assets.
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Past performance
Five of the Adani group stocks are listed in the Nifty Next 50 Index. These are Adani Total Gas, Adani Transmission, Adani Green Energy, Ambuja Cements and ACC.
To be sure, the fall of Adani group stocks and its impact on the Nifty Next 50 index is only a recent occurrence. Over the long term though, the Nifty Next 50 index has been impacted by the underperformance of various other stocks. These include the likes of new-age recently-listed companies such as Zomato, Paytm Money and Nykaa. In the last one year, the share price of Zomato has corrected by about 35%. That of Nykaa is down 38%, while Paytm is down 24%.
The Nifty Next 50 Index is seen as a catchment space for stocks that could potentially graduate to the Nifty 50. While a few of them make the transition and turn into mega caps from large caps, several stocks lose their way and even end up getting excluded. The Nifty Next also holds some stocks dropped by Nifty 50 and these could underperform more during challenging market conditions.
For example, after underperforming for several years, Bharti Infratel (now Indus Towers) was excluded from Nifty 50 in August 2020 and moved to Nifty Next 50 Index. The stock has continued to underperform. In the last one year, its share price is down another 32%.
This is also the reason why Nifty Next 50 Index is more volatile than Nifty 50. Its standard deviation stood at 19.7 for a one-year period, compared to standard deviation of 17 for the Nifty 50.
Market experts say that only investors with tolerance for higher volatility should invest heavily in Nifty Next 50 Index, else an asset-allocation approach is advisable.
“The companies that are part of the Nifty 50 account for over 50% of India’s total market capitalization whereas the Nifty Next 50 Index has a 12-15% share. An investor can follow an asset allocation mix on similar lines to invest across these two indices,” said Anish Teli, founder of QED Capital Advisors.
Investors can also take a look at the stocks that are part of the index (disclosed in index factsheets) and evaluate if they are comfortable with investing in such stocks, he added.
Group exposures
It is not uncommon for a business group to have a larger weightage in domestic indices. For example, the Tata group companies account for 8.5% weightage in the Nifty 50 Index, with five Tata group companies being part of the index.
“For India, diversification at group level is as important as diversification at the security level. For that, we need a robust mechanism for defining and tracking group relationships. Global index providers collect this data, but it’s not always perfect,” said Sivanath Ramachandran, director of capital market policy, CFA Institute.
Rather than focusing on group exposures, advisers say investors should check whether they are comfortable with the strategy followed by the index. By design, a regular index will not be valuation conscious. The stocks with rising market capitalization will continue to see their weightage rise in an index, regardless of their valuations.
This is what exactly transpired in the case of Adani group stocks. Adani Green Energy and Adani Total Gas traded at 12-month trailing price-to-earnings (P-E) of more than 700-times, while Adani Transmission traded at P-E multiple of over 400-times. Due to these high valuations, actively-managed schemes largely steered clear of Adani group stocks, but regular indices included them.
“Here, factor-based indices can be considered. A factor-based index can screen out 20-30 top companies (in terms of market capitalization), which are more suited to the investor’s risk-profile. For example, Nifty Low Volatility Index is useful for investors looking for less volatile Nifty companies. Nifty Value Index offers exposure to companies that are trading at lower valuation multiples,” said Kavitha Menon, founder of Probitus Wealth.
Sticking to index funds?
When it comes to large cap segment of the market, actively-managed funds have found it difficult to outperform the large cap indices in the past. In mid- and small-cap segment, actively-managed funds have shown more instances of outperformance when compared to their benchmark indices. So, index investing continues to have a strong use-case, especially in the large cap segment of Indian markets.
According to Vishal Dhawan, founder and chief financial planner of Plan Ahead Wealth Advisors, the strength of index investing over actively-managed funds is that it takes away individual biases. “For example, if a stock or group of stocks continues to fall, they would eventually get excluded from the index. However, investors may continue to hold the stock in expectation of a recovery, which may or may not take place,” Dhawan said.
Anubhav Srivastava, partner and senior fund manager at Infinity Alternatives, echoes this view. “There is a self-correcting mechanism in an index. Stocks that correct gradually see their weightage diminish in the index. Eventually, if a stock falls significantly in its value, there is index re-balancing at regular intervals when such stocks are excluded and new stocks are included,” he said.
An index can go through temporary bouts of volatility when a heavy weight stock or group of stocks comes under pressure. But, remember indices are not fixed; their composition keeps changing and consistent underperformers get excluded over time. Nifty Next 50 Index is still a narrower index as it represents 12-15% of total market capitalization, which makes it more vulnerable to market volatility. Investors looking at index-based investing can consider broad-based indices like Nifty 50 Index or even Nifty 500 Index for wider diversification.
And if you are not comfortable with a regular index, evaluate your investment strategy and consider a factor-based index.