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What is an equal weight index fund and how does it work?

In an equal weight index, all the index constituents with equal weightage, irrespective of their market capitalisation. In this article, we will understand in-depth what is an equal weight index fund and how does it work.
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Did you know that as of 29th October 2021, in the Nifty 50 Index, the top 3 stocks (Reliance Industries, HDFC Bank, and Infosys) have a combined weightage of 27.8% and the top 10 stocks have a combined weightage of 58.36%? It results in a heavy concentration of the top 10 stocks. If the top 3 stocks don’t perform well for any reason, it can impact the overall returns of your Nifty 50 index fund. To overcome this situation, you can consider an alternate approach to index investing, which is investing in equal weight index fund. In this article, we will understand what are equal weight index funds and how do they work.

What is an equal weight index?

We have all heard of the Nifty 50 Index. In this index, the constituents have weightage as per their market capitalisation. For example, Reliance Industries has the highest market capitalisation. Hence, it has the highest weightage in the Nifty 50 Index. So, this is the market capitalisation approach.

However, an equal weight index works differently. In an equal weight index, all the index constituents start with an equal weightage. For example, a Nifty 50 Equal Weight Index will have an equal weightage of 2% to each of its 50 constituents, irrespective of their market capitalisation. So, in a Nifty 50 Equal Weight Index, Reliance Industries, which has the highest market capitalisation, will have a 2% weightage, and the 50th stock with the smallest market capitalisation will also have the same weightage of 2%.

How does an equal weight index work?

All the constituents of the equal weight index start with the same weightage. For example, in the case of the Nifty 50 Equal Weight Index, all constituents will start with a 2% weightage. With time, depending on the performance of the share prices of the constituents, the weightages will change. Accordingly, the rebalancing of weightages is done quarterly, wherein the weightages of all constituents are rebalanced to equal. 

So, in the case of the Nifty 50 Equal Weight Index, the weightages of all constituents are rebalanced to 2% each during the rebalancing exercise. In the case of stocks whose prices have gone up, and accordingly, weightage has gone up, their weightage will be revised down back to 2%. In the case of stocks whose prices have gone down, and accordingly, weightage has gone down, their weightage will be revised up back to 2%.

Features of an equal weight index

Now that we understand what an equal weight index is, let us understand its features.

  1. Equal weight of constituents

    The most important feature of an equal weight index is all its constituents start with an equal weightage.

In an equal weight index, during the quarterly review, the weightages of all the constituents are adjusted and brought back to the same level.

As seen in the above image, the weights are evenly spread, but still, the weightage of Tata Motors (1st constituent) is 2.93%, and that of Divi's Laboratories Ltd. (last constituent) is 2.09%. The variation is because the stock of Tata Motors has done very well during the current quarter, and the stock of Divi's Laboratories Ltd. has done marginally well. During the quarterly review, the weightages of all the constituents will be brought back to 2%.

  1. Quarterly rebalancing

    In an equal weight index, during the quarterly review, the weightages of all the constituents are adjusted and brought back to the same level.

    As seen in the above image, the weights are evenly spread, but still, the weightage of Tata Motors (1st constituent) is 2.93%, and that of Divi's Laboratories Ltd. (last constituent) is 2.09%. The variation is because the stock of Tata Motors has done very well during the current quarter, and the stock of Divi's Laboratories Ltd. has done marginally well. During the quarterly review, the weightages of all the constituents will be brought back to 2%.
  2. Returns given to investors

    Based on historical data, the Nifty 50 Equal Weight Index has given better returns as compared to the Nifty 50 Index based on market capitalisation.

equal weight index funds

As seen in the above image, a lump sum of Rs. 1 lakh invested in the Nifty 50 (market capitalisation) index would have grown to Rs. 20.09 Lakhs. The same lump sum of Rs. 1 lakh invested in the Nifty 50 Equal Weight Index would have grown to Rs. 29.66 Lakhs.

Similarly, a monthly SIP (systematic investment plan) of Rs. 10,000 (total investment of Rs. 26.8 lakhs) would grow to Rs. 1.94 crores (CAGR of 15.35%) in the Nifty 50 (market capitalisation). The same SIP would grow to Rs. 2.27 crores (CAGR of 16.43%) in the Nifty 50 Equal Weight Index.

So, the Nifty 50 Equal Weight Index has given better returns over the long investment time horizon than the Nifty 50 Market Capitalisation index.

  1. Fundamentals

    The valuation parameters of the Nifty 50 Equal Weight Index are better than that of the Nifty 50 Market Capitalisation Index.
equal weight index funds

Note: The above data is as of 30th September 2021.

As can be seen from the above table, the price-to-earning (P/E) ratio and the price-to-book (P/B) ratio of the Nifty 50 Equal Weight Index is lower than the Nifty 50 Market Capitalisation Index, which is good from an investor’s point of view. Similarly, the dividend yield of the Nifty 50 Equal Weight Index is higher than the Nifty 50 Market Capitalisation Index, which is good from an investor’s point of view.

  1. Diversification

The Nifty 50 Equal Weight Index offers better diversification to investors as compared to the Nifty 50 Market Capitalisation Index.

equal weight index funds

(Source: https://invest.dspim.com/nfo/dsp-nifty50-equalweight-etf/docs/DSP-Nifty-50-Equal-Weight-ETF-NFO-Presentation.pdf)

Note: The above data is as of 30th September 2021.

The above table shows that the Nifty 50 Market Capitalisation Index has high exposure to financial services (37.2%) and IT (17.4%) sectors. In the case of the Nifty 50 Equal Weight Index, these exposures are 21.7% and 9.7% only.

The top 5 sectors have a total exposure of 82.8% in the case of the Nifty 50 Market Capitalisation Index. In the case of the Nifty 50 Equal Weight Index, the top 5 sectors have a total exposure of 65.3%. So, the Nifty 50 Equal Weight Index offers better diversification to investors than the Nifty 50 Market Capitalisation Index.

Investing in equal weight index funds

Now that we have understood the features of equal weight index funds let us see how we can invest in them. Equal weight index funds are available on the Nifty 50 Equal Weight Index and the Nifty 100 Equal Weight Index.

Fund nameAUM (Rs. crores)3 months1 year3 years
Nifty 50 Equal Weight Index Funds
DSP Equal Nifty 50 Fund253.5911.05%69.91%19.20%
Aditya Birla Sun Life Nifty 50 Equal Weight Index Fund75.2211.05%NANA
Nifty 100 Equal Weight Index Funds
Principal Nifty 100 Equal Weight Fund29.278.85%63.86%17.67%
Sundaram Smart Nifty 100 Equal Weight Fund36.628.95%64.36%17.97%

(Source: www.moneycontrol.com)

Note: The above returns are as of 2nd November 2021. The above returns are for direct funds with growth option.

The Aditya Birla Sun Life Nifty 50 Equal Weight Index Fund was launched a little over three months back. Hence the one and three-year returns are not available.

In the future, more mutual fund houses are expected to launch more index funds on the Nifty 50 and Nifty 100 Equal Weight Indices.

Asset allocation with Glide Invest App

Index funds should be a part of your investment portfolio. However, you need to follow appropriate asset allocation to diversify your investment portfolio as per your risk profile. Appropriate asset allocation includes investing in various asset classes like equity, debt, gold, real estate, alternative investments, etc. You can partner with the Glide Invest App to understand your risk profile and get recommendations for the appropriate investment products. You will get advice on how to plan and systematically invest towards your financial goals

With Glide Invest, you will get guidance for:

  1. A personalised risk profile assessment
  2. Identifying your financial goals
  3. Appropriate asset allocation
  4. Making a financial plan for each goal
  5. Automating the financial plan
  6. Review and analysis of your financial plan 
  7. Hand holding you till your financial goals are achieved

To start investing towards your financial goals, download the Glide Invest App from Google Play Store or Apple App Store and get started.

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