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Sunday, December 05, 2010

Alternative stock market indexes

I saw this interesting article about the mind-share of Nifty as opposed to the BSE Sensex. It is by Samie Modak and Muthukumar K. in the Financial Express.

The NSE data for June 2010 shows that Nifty futures have peaked at Rs.0.36 trillion of notional turnover in a day (27 Jan 2010) and Nifty options have peaked at Rs.0.89 trillion of notional turnover in a day (24 June 2010). Nifty has shaped up as one of the big contracts by world standards. It is interesting to go back and read the original paper. Those were interesting times. Looking back, it seems obvious that Nifty would dominate the derivatives market, but at the time, the outcome was far from clear.

This made me look at data on risk and reward of the alternative indexes. I start from the first data for Nifty Junior, which takes me back to 21 February 1997, thus giving data for 13.7 years.

Mean Volatility Ratio
Nifty 12.99 26.37 0.4926
BSE Sensex 12.68 26.92 0.4711
Nifty Jr. 18.16 32.38 0.5608
CMIE Cospi 17.40 27.23 0.6391

Nifty and the BSE Sensex are a lot like each other.

The real surprise is Nifty Junior: Merely moving down from rank 1-50 to ranks 51-100 has given an enormous juice in the return and in the reward-to-risk ratio. But the volatility of Nifty Junior is also higher.

The CMIE Cospi index has roughly 2800 stocks today, and represents the broad market. It includes the Nifty Junior stocks and a host of other smaller stocks. But unfortunately, these numbers are not comprabale with the other three in that it includes dividends while the other three do not. With this combination of high diversification (giving a low volatility), small-cap stocks (which helps returns) and inclusion of dividends (which helps returns), it is not surprising that it scores the best reward-to-risk ratio.

In my mind, most of the claims of out-performance by active managers in India are purely about being invested in the non-Nifty space. Nifty Junior ETFs are easily accessible and I get surprised that more people aren't putting this into their investment strategy.


  1. COSPI to my mind offers the best option for passive investing. But, unfortunately as of now it is not an investable index. But, I am hoping that the benchmark guys soon launch the ETF on the s&p cnx 500. I think that index offers the next best passive investment opportunity, after COSPI. For about the same std deviation (~27% p.a.), the index offers much better returns than the nifty. This index allows one to capture evolutionary returns from emerging companies (say for a eg a Thermax going from a 1000 cr mcap to 10,000 cr mcap or a coromandel intl going from 800 cr mcap to 9000 cr mcap...etc).

  2. It is nothing but popular size effects. If you invest in mid cap and small cap, you will get higher return for higher risk you are taking. In long run mid cap and small cap beats large cap. It is an another Beta strategy. It is not ALPHA strategy.

  3. correction to my earlier comment - benchmark already has an ETF on s&p cnx 500 for more than a year now!

  4. 1) Isn't COSPI too close to the Korean Index?

    2) Is COSPI market cap weighted? Then it will be skewed towards the top anyhow.

    Btw, just equal weighting the companies in teh Nifty will dramatically change returns and volatility. Gotta test....

  5. 1) Isn't COSPI too close to the Korean Index?

    {{- NOPE. It stands for CMIE Overall Share Price Index. It is India's own wilshire total market index, but unfortunately not yet investable, but am sure some day it will be & till then s&p 500 is a good option.-}}

    2) Is COSPI market cap weighted? Then it will be skewed towards the top anyhow.

    {{- It comes in both the forms, market cap weighted as well as equal weight. The market cap weighted does get skewed towards the top, but it still delivers a better risk-adjusted return. Think of it this way, by the time NTPC was included in the NIFTY, it already had a market cap of close to Rs.160,000 crore, as compared to Rs.58,000 crore some time after its listing. Broader market indices capture evolutionary returns, for a long term passive investor, they offer the best risk-adjusted returns.-}}


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