The Echo-nomist

While talking about how the market performed today, you often hear “Oh Nifty was down 1%” or “Sensex was up 0.5%.” Benchmark indices such as these are ways to quickly measure the market sentiment, how it’s performing etc. But these indices don’t always tell the full story of a country’s markets. Especially in India, where the economic and market dynamics have evolved so much over the last few years, I’ve been thinking: Is the Nifty 50 still enough?

Throwback to 1996: it was the year the Nifty 50 was born. Back then, it was a representative index—capturing the largest companies across sectors, acting as a strong measure for the Indian equity market. Even in 2014, the Nifty 50 represented a whopping 67% of the total market capitalization of India’s stock market. That’s pretty decent. 5 years later, in March 2019, it represented 59% of the total market capitalization. Fast forward another 5 years to August 2024, it captures only 42.2% of the total market capitalization. Its representation has declined, and rapidly at that. The case for Sensex is something similar. In 2014, the sensex represented nearly 60% of the total market cap of BSE. However, this number stands at 35% as of September 2024. What happened in the last few years??

The answer lies in how India’s market has expanded. Mid-cap and small-cap stocks have grown rapidly, and new sectors like technology, renewable energy, and e-commerce have emerged. Between 2019 and 2024, the total market capitalization of midcap companies has surged by 360%, while small-cap companies have seen a growth of 290%. Think about companies like Zomato, Nykaa, and Paytm—these weren’t around when the Nifty 50 was created, but they’re major players now. Zomato and Jio Financial Services might replace 2 companies in the Nifty 50 during its rebalancing. The result? The Nifty 50 is starting to feel like an outdated playlist—it’s missing the new hits.

The shrinking representation of the index is more than just a number that shows market movement.

Mutual funds and ETFs tied to outdated benchmarks might offer stability, but they fail to capture the full upside of these emerging players, leaving a gap in potential returns. Investors are missing out on midcap companies that are driving the next wave of growth. There are 22 ETFs in the market which track the Nifty 50. But how is it an accurate tool for the investors if it represents only 43% of the market?

Another issue is the concentration of industries. Despite its shrinking share of total market capitalization, the Nifty 50 remains heavily skewed toward a few sectors. For instance, financial services and IT often account for nearly 40% of the index’s weight. While these sectors are undoubtedly important, they don’t represent the full diversity of India’s economy. Sectors that are playing an increasingly important role in driving employment and economic growth such as renewable energy, pharmaceuticals, etc. are underepresented. The pharma industry, for example, has been a global leader since the pandemic. However, Sunpharma is the only pharmaceutical company that’s listed on Nifty 50.

Last week, when the markets were in red, the sector that was doing comparatively okay was IT. Since IT accounts for a significant portion of Nifty, the drop is Nifty was 2.5% throughout the week whereas the combined market cap of midcap and small cap companies experienced a drop of 4-6%.

The indices also paint a narrative about India’s economy. The movement of these indices can also effect global investor sentiment. The Nifty 50 can no longer carry the weight of representing an entire market, especially one that’s as dynamic as ours.

In the US markets, in contrast, the S&P 500 index accounts for 77% of the total market capitalization, and the NASDAQ Composite represents 88%, making them representative benchmarks.

Hopefully you’re convinced that we need new indices. The next question is, what’s the solution?

3 alternatives came to my mind.

One option can be to have 500 top companies by market capitalization, like the S&P 500. In March, 2024 this index would’ve represented 93.35% of the total market capitalization. That’s a pretty significant number. Including 500 companies in the index would lead to diversification, covering a variety of sectors and companies from large cap, small cap and mid cap.

Another option could be to include the top comapnies from multiple sectors including Pharmaceuticals, FMCG, Healthcare, IT, Media, Metal, Oil and Gas, Banking, Realty, Financial Services, Auto, etc. The companies from each sector can either be chosen based on their market capitalization or based on the trading volume. This would also serve the purpose of diversification, painting a more holistic view of the markets and its growth story.

The third option is slightly more complex. NSE/BSE could establish a benchmark where the index consistently represents approximately 80% of the total market capitalization. To do so, they could include the top companies contributing to this 80%, with the composition reviewed and updated semi-annually or annually. This would ensure the index remains reflective of the market’s overall dynamics and continues to capture a substantial share of its total capitalization.

With the growth of retail investors in the markets, the need for new indices becomes more practical. For individual investors, it can be impactful in the form of new ETFs and investment products that are tailored to India’s evolving market. A well-diversified, updated index would make the Indian market more attractive to overseas investors.

The Nifty 50 and Sensex have served the Indian markets well but it’s time for an update. Our markets have grown, diversified and transformed so it’s only fair that the benchmarks keep up.

What are your thoughts?