A powerful formula for long term wealth creation

As we celebrated International Women’s Day two weeks ago, Hong Kong Stock Exchange was in the spotlight with their new rule that any company wanting to get listed, needs to have at least one female director, and existing listed companies must have gender-diverse boards by 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, analysing data based on BRSR reporting by listed companies (I am associated in volunteer capacity as a Board Member). In India we have seen a very prudent regulatory transition on this front initiated by SEBI since a few years and now across almost all of the top 1000 listed companies, we have at least one woman board member. 

Why are stock exchanges and regulators across the globe increasingly nudging 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 discovering that having a wide range of perspectives and experiences is critical to a company’s long term growth and sustenance. Rapidly changing consumer demographics and choices make it even more crucial to have a diverse management at the top to enable businesses to flourish. Equal representation to women, men, young and old, persons with technical as well as managerial skills is the only way the dynamic challenges and risks being encountered 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 at the helm? The best approach would be to have a Board that consists of industry leaders who can help tide through phases of the business and achieve wealth creation over a longer term. Each of them are given an equal say in all company matters, leaving no chance for one member to influence the decisions of the Company. 

An equally weighted index fund mimics all the characteristics of this diverse, experienced and well-represented Board. Simply put, the strategy allocates an equal weight to all the stocks in the index as opposed to following a market cap weighted approach where the stocks with the highest free float market capitalization are assigned the highest weights. 

This magic ingredient of equal weights, when applied to one of the sturdiest indices in India, the Nifty 50 Index, becomes a great recipe for compounding one’s investments. While it draws the benefits of investing in strong companies that have navigated several business cycles, it at the same time, doesn’t give few stocks too much importance simply because they have the largest free float market capitalization. Undue concentration risk of investing in a few stocks or a heavy tilt towards a couple of sectors is therefore avoided. 

The concept of an equal weight index was introduced in the US during early 2000’s with the S&P 500 Equal Weight Index. Following the US markets, there have been many developments globally, including in India where DSP Mutual Fund had launched India’s first Index Fund in 2017 using equal weight strategy on the Nifty 50 Index. Historically, the S&P 500 and other equal weight indices have outperformed their market capitalization weighted equivalent indices over longer time periods with some interim periods of both, outperformance as well as underperformance.

In India too, we have observed that the Nifty 50 Equal Weight Index has had a similar outperformance over longer periods of time against the Nifty 50 Index with annualized outperformance of 2% CAGR from June 1999 to December 2022. If we break it up in shorter periods, the Nifty 50 Equal Weight Index has outperformed in 14 out of 23 calendar years. The level of outperformance has varied considerably during different market conditions - maximum outperformance is seen during periods of depolarization. While polarized markets tend to cheer on index heavyweights, a more broad-based rally puts the tail of the index in a winning position, which is what was observed in the recovery after the Great Financial Crisis in 2009, or more recently post the Covid-19 market crash in 2020. 

If you are an investor doing your annual portfolio review around Women’s Day, or you are a  HNI investor looking to complete your investments before March year end, the attractiveness for you would be gain access to a portfolio which meets the two basic principles of investing in leaders and diversification across companies and sectors, a smart strategy which has potential to outperform market cap indices as seen in the past – while keeping the overall portfolio cost low. On the other hand, if you are a sophisticated institutional investor like a corporate treasury or an exempt PF Trust, the added reason for you to invest other than potential to outperform would be that equal weighting creates a different set of risk exposures and return potential when compared to market cap weighting and hence it offers a good diversification. 

Index investing can be simple yet based on powerful investment principles. At DSP Mutual Fund we believe ETFs and Index Funds could be a useful addition in investor’s portfolio allocation and we have undertaken various investor education initiatives to increase awareness, such as our recent #LetsIndex campaign. As we saw with this example of equal weight strategy, often the most powerful investment ideas are simple. There is no complex formula or theory applied here. A very simple logic - let all Board Members work equally hard to make sustainable strategies for long term business growth - let all companies in the portfolio play equal role in the long term wealth creation for you.

Author: Anil Ghelani, CFA Head of Passive Investments & Products – DSP Investment Managers