Top 5 = 44%, Top 10 = 62%: Concentration Risk in Nifty 50?

Nifty 50, as you know is made up of 50 stocks of different weightages. And generally, it is accepted to be a well-diversified index that represents the Indian markets sufficiently well. But in recent times, the skewed weights of few of the top stocks in the index are posing questions about whether it is actually as well-diversified as claimed or not.

If you look at the Sep-2020 data of index constituents and weightages, you will notice that out of the 50 stocks in the index:

  • Top 3 stocks in Nifty50 account for 32.2% weightage
  • Top 5 stocks in Nifty50 account for 44.0% weightage
  • Top 10 stocks in Nifty50 account for 62.1% weightage

This is a very high level of concentration in just a few stocks if you ask me. Monthly data is regularly updated on NSE’s website here.

And here is a list of top 10 stocks with weightages:

  1. Reliance Industries – 14.9%
  2. HDFC Bank – 9.67%
  3. Infosys – 7.62%
  4. HDFC – 6.43%
  5. TCS – 5.4%
  6. ICICI Bank – 5.05%
  7. Kotak Mahindra Bank – 3.83%
  8. HUL – 3.81%
  9. ITC – 3.09%
  10. Larsen & Toubro Ltd – 2.27%

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And if I am not wrong, then this dominance of top-5 and top-10 stocks the index are at an all-time high (or very close to it). Have a look at the table below which shows the weightages of all the 50 constituents of Nifty 50 index (you can even download the table here):

Nifty 50 Top 3, 5 and 10 Stock Concentration (Sep 2020)

And if you haven’t noticed then let me highlight few more things for you:

  • The weight of Reliance (RIL) is 14.9% and that is more than the combined weight of the last 23 stocks in the index! So much for diversification. Isn’t it?
  • Even the top 2 stocks (RIL and HDFC Bank) form almost a quarter of the index weight at more than 24%
  • And if you look at the HDFC twins of i) HDFC Bank and ii) HDFC Ltd., then they too pose a concentration risk if combined with RIL at more than 30%. (Again) so much for the sake of diversification.

But that is not all from the polarization perspective.

Even the sector concentration has increased a lot. In fact, as per the latest data, the combined weight of just 4 sectors of financial services, oil and gas, information technology, and consumer goods is nearly 77% of Nifty50 (source).

The more concentrated an index, the higher is its vulnerability. And that is the whole premise of having a well-diversified index that spreads the bets across various stocks and sector sufficiently well. But Indians indices like Nifty 50 and Sensex now carry (higher than ever) concentration risks because of the high weights being assigned to the top few stocks and sectors.

Compared to indices like the S&P 500 and Nasdaq in mature markets, the problem is bigger for Indian bellwethers like Nifty50 and Sensex. Indices like S&P500 and Nasdaq have diversified their portfolio in 500 and 100 stocks respectively. But in India, Nifty has it in 50 and Sensex at even lower 30 stocks. That too skewed towards just a few top 5-10 stocks as explained earlier.

(To know more about various indices, do read Explained: Nifty Indices like Nifty50, Nifty Next 50, Nifty 500 & Others)

And since the index funds and ETFs in India which replicate these indices have similar portfolio composition, they too expose themselves to this risk which results in higher concentration of portfolio in just a few stocks. This is something to made note of by the index funds investors.

Such concentration risk is comparatively lower in actively managed funds. And this is because to handle this risk, there are some rules. As of now, the latest SEBI guidelines for mutual funds do not allow actively managed equity schemes to own more than 10% in a single stock. After this limit is hit, the weight of a stock in a scheme can go up only to the extent of the rise in its share price. So the regulator has actually done well to put in place some rules to protect common MF investors from the concentration risk of over-exposure to few stocks, group or sector.

So unlike the index itself (and the passive funds/ETFs replicating it), an actively-managed fund’s manager can avoid taking bets that are too concentrated or make the portfolio uncomfortably risky. At least he has the option to limit his exposure that is not possible in passive funds.

Please don’t think that I am trying to bash up the passive form of investing here in favour of active fund management. I am only highlighting the gradual build-up of a new kind of risk (concentration risk) which many people following the index aren’t aware of.

(Soon, I will try to write in detail about the index funds vs large-cap funds discussion)

I personally follow a strategy of using a combination of actively-managed and passive index funds for investing in large-cap funds in my mutual fund portfolio.

And what should you do?

To each his own. And it depends on one’s risk appetite, financial goals and understanding of the markets. When doing taking client for Full Goal-based Financial Planning or for HNI Advisory, I review and customize their mutual fund portfolios as per their unique requirements. At times, it is enough to have just the passive funds when the investor has low equity exposure and belong to the conservative category. At other times, it’s a combination of passive and active funds.

If you are unable to manage your investments and are not sure how to divide your portfolio between active and passive funds, then its best to contact a SEBI-registered Investment Advisor to help you with it.

If you are confused between choosing the right large-cap fund or picking the index funds instead, then here is something that can help you. Stable Model Mutual Funds is a premium subscription service that provides you with instant access to a ready-to-use list of investment-worthy Equity& Debt Mutual Funds. The fund recommendations are monitored and reviewed on an on-going basis (and you are updated once every quarter), so you can rest assured that you can continue to remain invested in good funds. If you wish to pick the right funds for your MF portfolio, then you can SUBSCRIBE Here.

1 comment

  1. Very informative with clear vision. Must guide less informed NRI’s of Dubai & GCC Countries. Good work. Cong.

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