As we celebrated International Women’s Day two weeks ago, the Hong Kong Stock Exchange was hitting headlines with its new rule that any company that wants to be listed must have at least one female director, and that existing listed companies There should be gender-diverse boards. At the end of 2024. Closer to home, I was at a CFA Society India event in Mumbai where we released a report titled Mind the Gender Gap, which analyzed data based on BRSR reporting by listed companies (I am a board member). Connected in a volunteer capacity) ). In India we have seen a very judicious regulatory change on this front initiated by SEBI since few years and now in almost all the top 1000 listed companies, we have at least one woman board member.
Why are stock exchanges and regulators around the world increasingly pushing companies to appoint a more diverse, well-rounded board of directors, including independent directors? With increasing emphasis on adopting best practices in corporate governance, researchers are finding that having a broad perspective and experience is important for a company’s long-term growth and sustenance. Rapidly changing consumer demographics and choices make it even more important to have a diverse management at the top to enable businesses to thrive. Equal representation for women, men, young and old, persons with technical as well as managerial skills is the only way the dynamic challenges and risks faced by corporates every day can be mitigated.
Think of your investment portfolio as a business venture that you own as an entrepreneur. Wouldn’t you, as a promoter, want a solid board of directors? The best approach would be to have a board that has industry leaders who can help tide the business through the phases and achieve wealth creation over the long term. Each of them is given equal rights in all matters of the company, leaving no chance for any one member to influence the decisions of the company.
An equal weighted index fund mimics all the characteristics of this diverse, experienced and well-represented board. Simply put, the strategy allocates equal weighting to all stocks in the index, as opposed to following a market cap weighted approach, where the highest weighting is given to stocks with the highest free float market capitalization.
This magical factor of equal weight, when applied to one of the strongest indices in India, the Nifty 50 Index, becomes a great recipe for multiplying one’s investments. While this draws on the benefits of investing in strong companies that have navigated multiple business cycles, it also tends to undervalue certain stocks simply because they have the largest free float market capitalizations. Hence undue concentration risk of investing in few stocks or leaning heavily towards certain sectors is avoided.
The concept of an equal weight index was introduced in the US in the early 2000s with the S&P 500 equal weight index. Following the US markets, there have been several developments globally, including in India, where DSP Mutual Fund launched India’s first index fund in 2017 using a strategy of equal weighting on the Nifty 50 index. Historically, the S&P 500 and other equal weighting indices have outperformed their market capitalization weighted peer indices over the long term with some interim periods of both outperformance as well as underperformance.
In India too, we have observed that Nifty 50 Equal Weight Index has performed at par with Nifty 50 Index over the long term with an annualized outperformance of 2% CAGR from June 1999 to December 2022. If we break it down in short. Period, the Nifty 50 Equal Weighting Index has outperformed in 14 out of 23 calendar years. The level of outperformance varies greatly during different market conditions – maximum outperformance is observed during periods of depolarization. While polarized markets cheer on the index heavyweights, a more broad-based rally puts the index’s tail in a position to win, similar to that seen in the recovery after the Great Financial Crisis in 2009, or more recently after Covid – 19 market crash in 2020.
If you are an investor and doing your annual portfolio review around Women’s Day, or you are an HNI investor looking to complete your investments before March year end, the attraction for you is to get access to a portfolio Which meets the two basic principles of investing. Leaders and diversification across companies and sectors, a smart strategy that has the potential to outperform market cap indices as seen in the past – while keeping overall portfolio costs low. On the other hand, if you are a sophisticated institutional investor like Corporate Treasuries or Exempted PF Trust, then the additional reason for you to invest other than the potential for outperformance would be that equal weighting creates a different set of risk appetite and potential returns When compared to market cap weighting and hence it provides a good diversification.
Index investing can be simple, based on powerful investment principles. At DSP Mutual Fund, we believe that ETFs and index funds can be a useful addition to an investor’s portfolio allocation and have undertaken various investor education initiatives to increase awareness, such as our recent #LetsIndex campaign. As we saw with this example of an equal weighting strategy, often the most powerful investment ideas are the simplest. No complicated formulas or theories apply here. A very simple argument – let all board members work equally hard to create a sustainable strategy for long-term business growth – let all companies in the portfolio play an equal role in long-term wealth creation for you.
Author: Anil Ghelani, CFA Head of Passive Investments & Products – DSP Investment Managers
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