There has been much discussion about active and passive mutual funds, and how to choose between their categories. As many active funds, especially large-cap ones, struggle to consistently outperform their benchmarks, investors are increasingly turning their attention to passive funds.
But did you know that within the large-cap passive space (the top 100 companies by market capitalization, according to the Securities and Exchange Board of India (SEBI)), there are multiple types of passive indices that investors can choose from?
On the traditional side, we have considered three indices: BSE Sensex, Nifty 50 and Nifty 100. On the smart beta side, there are eight options: Nifty 100 Alpha 30, Nifty 100 Low Volatility 30, Nifty 100 Quality 30, Nifty 100 Equal Weight, Nifty 50 Equal Weight, Nifty Next 50, Nifty 50 Value 20 and Nifty Top 10 Equal Weight.
It can be confusing, right? Should you choose traditional large-cap indices or smart beta indices, or both? Each of these 11 large-cap indices follows unique strategies. Based on a 10-year daily compound annual growth rate (CAGR) from April 1, 2015, to August 30, 2024, the average returns generated by traditional large-cap indices have been 12-12.5%, with high returns ranging from 17.6-18.3% CAGR and lows of 5.1-5.6%.
On the other hand, large-cap smart beta indices have delivered average returns of 11.4-15.9% CAGR, with maximum returns ranging from 16.3-24.3% and minimum returns between 2.7-9.4% CAGR. This clearly demonstrates that large-cap smart beta indices have often outperformed their traditional counterparts.
While certain large-cap smart beta indices may be more volatile and exhibit cyclical behavior compared to traditional large-cap indices, they have demonstrated the strength to outperform at trough, peak, and average levels over the long term.
To further analyze the performance difference between smart beta and traditional indices, let us look at the percentage of time each category has generated returns greater than or equal to 15% CAGR. From April 1, 2015, to August 30, 2024, large-cap smart beta indices have generated returns of 15% or more in 51-66% of cases, while traditional indices have achieved this level only in 11-16% of cases. This clearly indicates that large-cap smart beta indices have outperformed traditional large-cap indices in terms of generating higher returns more frequently.
Among the large-cap smart beta indices, Nifty 100 Alpha 30, Nifty 100 Low Volatility 30, Nifty Next 50 and Nifty 50 Value 20 have emerged as clear winners in terms of delivering superior risk-adjusted returns, outperformance and consistency compared to the others.
Now, how should investors choose among these large-cap smart beta indices? The answer is simple. If your portfolio is tilted towards a growth style, choosing a value index like the Nifty 50 Value 20 can help balance it out. On the other hand, if your portfolio is tilted towards value, opting for a growth index like the Nifty 100 Alpha 30 or the Nifty Next 50 can prove beneficial.
Looking at the data, the Nifty 100 Low Volatility 30 seems to offer a sweet spot. It has delivered an average CAGR of 15.7% over a 10-year rolling daily period, which is on par with other leading indices. It has also delivered CAGRs of 12% or more more frequently than the others and has a higher 10-year trailing minimum return of 9.4% CAGR, better than its peers. With lower volatility and better consistency, the Nifty 100 Low Volatility 30 can be a good mix of growth and value for investors.
Does this mean that traditional large-cap indices are no longer relevant? Absolutely not. Traditional large-cap indices are simple, conventional options that reduce the complexity of product selection, help keep portfolios simple, and make it easier to understand market dynamics. They also generate returns that align closely with market performance.
Smart beta indices, while they can offer superior returns, can be more volatile and cyclical and may at times underperform. For investors who do not fully understand the intricacies of the smart beta index space, sticking with traditional indices may be the safest option. Regardless of the type of passive index chosen, it is important to select a passive fund with a lower expense ratio and tracking error, as this will help achieve returns closer to the respective index.
—Rushabh Desai, founder of Rupee With Rushabh Investment Services
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