By Chintan Haria
Benchmark indices are essential tools used to measure the performance of financial markets. There are several methodologies employed to construct and maintain benchmark indices globally. Some of the most popular ones are market capitalisation-weighted, price-weighted, equal-weighted, fundamental weighted and hybrid approaches (which use a combination of methodologies to construct a diversified index). But in the Indian equity market universe, most indices are based on the free-float capitalisation mechanism.
What is free-float capitalisation?
Free float market capitalization is the total value of a listed company’s outstanding shares that are available for trading in the open market. Free float excludes a company’s equity held by promoters, government bodies, trusts, and holdings which are subject to lock-up periods or any other restrictions. Here, market capitalisation is calculated by multiplying the company’s outstanding shares by the current stock price and represents the market value of a company’s outstanding shares.
Among the various market capitalisation methodology, free float is popular as this approach presents a practical picture of a company’s market value and liquidity. It considers only the number of shares that are available for trading at any given point in time. As a result, this metric is more useful when it comes to understanding the true picture of a company as the market value is not distorted. A sizeable free float is crucial for investors as it facilitates better price discovery and liquidity. Also, a large free float makes it more challenging to manipulate stock prices and hence boosts investor confidence.
In India, market capitalisation is decided on the basis of free float. For example: The Nifty50 index, based on the free-float mechanism, comprises the top 50 companies, in the Indian listed universe. These companies are also among the largest companies operating in their respective sectors and traditionally have a strong balance sheet, corporate governance standards and liquidity. As a result, investors by investing in this index will automatically get access to some of the top companies in the country.
What is Nifty50 ETF?
Nifty50 is the prominent equity index, consisting of 50 of the largest Indian companies in terms of market capitalisation that are listed on the NSE. The index is widely regarded as a barometer of the Indian stock market. It is often used by investors as a benchmark to measure returns due to its wide diversification in its constituents across sectors. While there are several ways to gain access to Nifty 50 companies, one of the simplest and cheapest way is through the Nifty 50 ETF (exchange traded fund) route.
A Nifty50 ETF is a passive mutual fund that endeavours to replicates the Nifty50 index in terms of constituents and proportion of weights, with minimal deviation. Hence, the return an investor gets is similar to that of the index returns minus expenses. One can buy and sell units of ETFs, just like a stock, at any point in time during the trading hours as they are listed on the stock exchanges. This makes the transaction very convenient. Being a passive fund, the fund management costs are negligible.
Since it is an ETF, an investor can buy or sell in multiples of one unit. One unit of ICICI Prudential’s Nifty50 ETF, as on June 09, 2023, is available at Rs203 and the expense ratio for the same is at 0.0279%. This is also the lowest expense offering in the category. So, with just Rs 203, an investor gets to invest in the top 50 companies in the country. To conclude, if you are looking to invest in Indian equities, then Nifty50 ETF is an easy and good starting point to gain exposure to a wide variety of Indian companies.
(Chintan Haria, Head Investment Strategy, ICICI Prudential AMC. Views expressed are author’s own.)