INSUBCONTINENT EXCLUSIVE:
disturbing phenomenon has far reaching implications for Indian investors.
The Nifty has fallen far behind the Indian economyOver the last 10
seen its earnings grow at a mere 8 per cent per annum
benchmark indices in India and the US display completely opposite trends (compared with the GDP growth of their respective economies) and
what implications does that have for investors
Why does Nifty lag Indian economyTo understand why Nifty no longer captures the dynamism of
the Indian economy, a good place to start is the index as it stood 10 years ago
On the face of it, the 10-year return from investing in Nifty is a very respectable 14 per cent but that is a deceptively flattering figure
A better way to understand the quality (or lack thereof) of Nifty is to look at the return from investing in the underlying 50 stocks, which
[Note: by starting the measurement in February 2009, when the market was close to its post-Lehman lows, we are giving the Nifty every chance
to benefit from an unusually low base.]
If you assume that the cost of equity of a typical investor investing in Indian stocks is 15 per
cent, only 18 out of the 50 stocks in the Nifty have given a return above the cost of equity over the past ten years
ICICI Bank, Grasim, LT and Sun Pharma
As you can see from the list, barring four companies, all the other companies are from relatively capital light and/or B2C sectors like
heavy sectors like power, construction, metals, telecom, real estate and oil gas.
These sectors accounted for roughly 30-35 per cent of the
And yet these companies account for two-thirds of the companies in Nifty leaving little room in the index for the more vibrant sectors of
the economy.
The over-representation in Nifty of the capital-heavy sectors of the economy is, therefore, a key reason its sluggish
It is not obvious to us why the Nifty continues to have such a high proportion of companies from balance sheet heavy sectors.
Secondly, over
This in turn is suggests that significant drivers of the Indian economy are no longer in the listed market.
For example, taxi aggregators
(Ola, Uber), online retailers (Flipkart, Amazon), electronics goods manufacturers, car manufacturers other than Maruti, hotels other than
Taj, Oberoi and Lemontree, etc are all unlisted
Basically most of the things that affluent India buys beyond FMCG and apparel is no longer in the listed market.
These companies are able to
access capital at low cost without entering the stock market and therefore their contribution to GDP is not reflected in the stock market
If, as the Indian economy matures, the unlisted world continues to provide capital at lower cost than the listed market then the gap between
GDP and market cap will widen further.
Implications for investorsThe sluggishness of Nifty makes its relatively easy for reasonably
competent fund managers to outperform the index and unjustifiably claim the presence of skill
While this does pose a challenge for Nifty tracker/index funds (since they are tracking a moribund index), it also opens up enormous
opportunities in India for smart beta funds.
For example, Nifty Junior (which represents the 50 most liquid stocks below the Nifty) almost
always outperforms the Nifty.
Given that nearly two-thirds of the Nifty constituents have failed to give a return above the cost of capital,
large cap Indian funds which draw their constituents largely from the Nifty are a difficult investment to justify
stocks - is able to deliver returns which are consistently above the cost of capital.
The inability of the Indian stock market to provide
lower cost funding than the Private Equity (PE) firms is depriving the Indian stock market of high quality companies which can dominate
The more important foreign companies and PE funded companies become in India, the bigger the questions mark around the relevance of the
much better than Indian companies in the Nifty
This not only raises troubling questions about the quality of capital allocation and accounting in many large Indian companies that are in
the Nifty, it also suggests that Indian investors should consider investing in a portfolio of global companies who dominate specific
segments on a worldwide basis.
(Saurabh Mukherjea is the author of The Unusual Billionaires and Coffee Can Investing: the Low Risk Route to
