March 27, 2015

when an investing strategy is found in an index

Index investing can offer interesting strategies. In a story/article I wrote, around two months back, for the newspaper I work for currently, I explain some of them for Indian investors.

Here is what I wrote:

When a strategy is found in an index

Rajesh Gajra
FC Research Bureau
January 26, 2015

In our domestic equity market, there are broad market indices, there are sectoral indices, there are thematic indices and then there is a new breed of indices known as strategy indices. FC Research Bureau decodes a few of the strategy indices which have come into existence in the domestic market in the past few years only.
National Stock Exchange of India (NSE) offers, as per its definition of strategy indices, 13 such indices, but FCRB covers only four interesting ones -- NV20, CNX Low Volatility, CNX Alpha and CNX High Beta.
NV20 index is a value index made up of 20 stocks which is aimed to capture the most liquid value stocks from the 50-stock CNX Nifty index. The current set stocks in this index comes from eight sectors and captures around 30 per cent of the aggregate market cap of all NSE-listed stocks. This stands apart from CNX Nifty's coverage of 23 sectors and 50 per cent of aggregate market cap at NSE.
In our analysis of returns, 20-stock NV20 has performed better than the parent index of 50-stock CNX Nifty from where its members come from, in the medium-term period of four years. From its average value in 2010 to its average value in 2014, NV20 recorded an absolute return of 50.7 per cent, while the corresponding return which CNX Nifty delivered was 34.8 per cent.
Clearly, the value universe from NV20, as defined and culled by its index methodology, has outperformed the returns from a healthy mix of value and growth companies in the liquid large-cap stocks universe from CNX Nifty index.
But different strategies unravel different results across various tenures. CNX Low Volatility index, for instance, offers the option of another interesting strategy to investors.
This index captures the 50 least volatile stocks meeting a joint criteria of the 300-most largest stocks in terms of free-float market cap and 300-most traded stocks based on the last six months turnover. Volatility among the eligible stocks is calculated using one year trailing prices, and the least volatile stocks are selected.
There is a belief among a section of investing community that low volatile stocks tend to perform better in the long run. So, how has CNX Low Volatility index fared? In the four year period from 2010 to 2014, and based on average of the values of the index in a calendar year, CNX Low Volatility delivered a 4-year absolute return of 121.0 per cent.
Clearly, this level of return is far higher than CNX Nifty's corresponding four-year absolute return of 34.8 per cent. What is more interesting is that in the short term the low volatility index has struggled to match the performance of the diversified, large-cap universe. From calendar 2013 to calendar 2014, CNX Low Volatility index delivered 23.2 per cent return on its yearly average values, while the broad-based CNX Nifty delivered 24.4 per cent.
The contrast to low volatility is generally seen in high-beta stocks which move far more than the index stocks. There is an index to track this -- CNX High Beta index.
With the same basic criteria as that of CNX Low Volatility index, except for the difference of capturing the stocks with the highest beta instead of lowest volatility, the CNX High Beta index has been volatile as far as its short-term and medium-term returns are concerned. In the four-year period from 2010 to 2014, it has given an absolute return of -16.4 per cent, a negative rate of return, while in the one-year period from 2013 to 2014, it delivered a rate of return of 24.7 per cent. The result is obvious -- in both the time periods CNX High Beta failed to exceed the returns given by broad-based CNX Nifty index.
CNX Alpha is another index which aims to attract investors seeking alpha returns from the equity market. The 50-stock CNX Alpha, which comprises of 50 most alpha stocks from a universe of 300 largest and liquid stocks, has delivered a four-year return of 70.2 per cent from 2010 to 2014 and a one-year return of 38.7 per cent from 2013 to 2014. True to its objectives, the CNX Alpha index managed to outperform the broad-based CNX Nifty index.
Currently, not all the strategy indices are directly actionable by investors. But there are two mutual fund schemes connected with two strategy indices which are with Securities and Exchange Board of India for approval. Around a year back, Motilal Oswal Mutual Fund submitted a draft proposal for regulatory approval for a index product tracking the CNX 100 Equal Weight index which is one of the 13 strategy indices which NSE offers. In this month, Reliance Mutual Fund has submitted a draft offer document for R*Share NV20 ETF which will mimick the returns of the NV20 index.
BSE, the second largest stock exchange in the country, too has a bouquet of seven investment strategy indices which includes S&P BSE SME index and S&P BSE Dollex 30. The choice for investors is clearly good currently but the choice of actionable products is still limited.