What makes Nifty smarter?

Sanjiv Shankaran

THE National Stock Exchange (NSE) launched equity trading in late 1994 and, along with that, came its index of 50 stocks - dubbed Nifty.

The Nifty, today, is offered as an investment portfolio by some mutual funds that manage index funds. Soon after NSE's formation, there was a debate about the quality of the leading indices, Sensex and Nifty. The debate seemed an extension of the proxy war between NSE and BSE - the challenger and the established player respectively.

Coming to the indices, the basic difference was that Nifty had a bigger basket, 50 stocks, as against Sensex's 30 stocks. At least to the cursory observer, the Nifty seemed better managed than the Sensex because of periodic reviews. Currently, the gap seems to have been bridged, with both the indices on par in terms of the way they are managed.

Today, the Sensex usually accounts for about 85-86 per cent of the Nifty's market capitalisation. Though the Nifty has 20 stocks more in its basket, practically all the heavyweights are common, suggesting that the indices should move in tandem. Not just in tandem, the magnitude of change in both should be largely similar. A look at the way they have moved over the last couple of years, however, suggests otherwise.

Between March 1999 and November 2001, the Sensex lost 10.17 per cent in value, while the Nifty actually gained 0.86 per cent. The difference is significant and quite surprising.

An explanation that comes to mind is the change in composition of four stocks in the Sensex in May 2000.

The emphasis shifted to companies that had recently caught market fancy such as Zee Telefilms, Dr Reddy's Laboratories and Reliance Petroleum. However, beyond the change in composition, there is little to explain the sharp divergence. A subject worthy of study.

Triggers remain the same: The divergence in the magnitude of change between Sensex and Nifty lead one to wonder if there would have been a difference in returns. No significant differnce is the verdict. Investing at the same time as one did in the Sensex between December 1998 and December 2000 would have led to the same returns.

Whatever it is that led to a change in the magnitude of returns between Sensex and Nifty, it did not have an effect on the performance of a notional investment in them during the bull run of 1999-2000.

But over a longer period, that is, a period encompassing the bull run and the subsequent sharp fall, the Nifty seems to have weathered the storm better.

Going forward, one cannot really see significant difference between the returns of the two most popular indices. Their market capitalisation is likely to have an overlap of about 80 per cent, and the difference is unlikely to produce significant difference.

Thus investing in either Sensex or a Nifty-based index fund are likely to produce approximately the same return.