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As expected, India has drawn the interest of both foreign and domestic investors eager to invest in its equity markets, a trend anticipated to persist.
Flipping through news channels or the morning newspaper these days, it’s hard to miss a headline about the Indian stock markets’ stellar rise. Nifty50, the stock market index which represents the 50 largest listed businesses in India, is currently at all-time highs. The businesses that form part of the Nifty50 index represent major sectors of the Indian economy such as Banks & Financial Services, Oil, Gas and Consumable Fuels, Information Technology, Automobiles, and so on.
As such, the components of the index broadly represent the underlying Indian economy. Also, these businesses are among the largest and leading names in their respective sectors, enjoying benefits of size and scale and resilience in nature given that they are well-established and reputed names. Since these businesses are widely tracked and well-regulated, the scope for negative surprises is relatively limited. As of September 29, 2023, the Nifty50 Index represents about 59% of the free float market capitalization of the stocks listed on the NSE.
So, if one wishes to create long-term wealth by participating in the India growth story, without taking too much risk, investing in the country’s fifty largest businesses which form part of the Nifty 50 index could be a straightforward strategy.
There are several ways to take this exposure. One could invest in the underlying 50 stocks directly, which could be a time-consuming process given that one would have to buy each of the stocks individually.
In addition, rebalancing their holdings periodically to keep stock weights in line with the index’s could be cumbersome as well as tax inefficient as such an investor would end up paying taxes on their gains at the time of sale. On the other hand, if they prefer a more convenient and hands-off approach to owning the largest Indian businesses, they could choose the mutual fund route by investing in a Nifty 50-based index fund or an exchange-traded fund (ETF).
Understanding Nifty50 ETF
A Nifty50 ETF or exchange-traded fund is a passively managed fund that invests in the constituents of the Nifty50 index to replicate its index constituents and consequently its returns. An ETF differs from an average mutual fund as their units can be bought and sold on exchanges at real-time prices based on demand and supply during market hours, unlike mutual funds whose units can be redeemed only with the mutual fund at end of market day prices. Investors can invest in ETFs through stock exchanges using a Demat account.
While choosing a Nifty50 ETF, one should look out for the fund size and its trading volumes which can reasonably indicate the ease with which one can liquidate their ETF holdings at fair prices.
One should also be mindful of the ETF’s expense ratio. The lower the expense ratio, the better it is for the investor as a larger part of the gains can be passed on. Last but not least, one should check the tracking error of the ETF before investing. Simply put, tracking error is the difference in returns of the ETF and the securities or index it is tracking. While some tracking errors are inevitable given the ETF’s expenses and other operating factors, ETFs with low tracking errors should be preferred.
(Chintan Haria, Principal - Investment Strategy, ICICI Prudential AMC)
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