On April 12th 2023, The Business Standard reported the Nifty criteria may be tweaked before RIL’s financial services arm demerger as the current rule could lead to the firm’s exclusion from the index.
On Feb 24th 2022, the NSE announced that the “Minimum listing history requirement in case of a new listing and companies traded subsequent to the scheme of arrangement for corporate events” was revised from three months to one month”. This allowed new companies like Paytm (One 97 Communications Ltd.), Zomato and Nykaa (FSN E-Commerce Ventures Ltd. ) to be part of the index from March 31st 2022. At that time, it was seen as a move to fast-track LIC into the indices, but that has not yet occurred.
On Nov 18th 2022, NSE revised its index composition methodology regarding mergers. This was done to ensure HDFC, which was to be merged with HDFC Bank, did not leave the Nifty.
These developments are a grim reminder that indices and passive investing are subject to curation risk. Frequent changes in index rules, even if necessary, tell you that the Nifty or Sensex is based on an arbitrary set of rules and the index curator is, just like the regulator, just like the product manufacturer, just like the journalist, just like the investor is also living and learning. When these tweaks favour investors or at least do not affect them, no one complains, but that may not always be the case.
Imagine for a moment RIL is dropped from the index. Would that make it easier for active largecap funds to beat the Nifty (until its re-inclusion)? It is not unreasonable to expect it, given how concentrated the Nifty or Sensex is – Do index fund returns depend upon just a few stocks (Concentration risk)?
Passive funds may not have the price issues (lower fees) and cost issues (no fund management risks) associated with active funds. But that does not mean passive funds are risk-free. They do suffer from rules changes or curation risks. So we can run from risks but cannot hide!
Curation risks may be lower than fund management risks, but they are still there. Something that index investors and passive investing champions should not forget.
Please note: We are not trying to claim that passive investing is a bad choice. They are still a better choice than active funds but far from perfect. In fact, it would be better to treat passive investing as a choice and not the choice and focus on more important aspects of investing – The “active vs passive” debate is not of primary importance in portfolio management.
Like in life, it is better to have an equitable approach to investing as well instead of blindly supporting one camp or the other.
Related read: Is it time for performance-linked fees in active mutual funds?
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Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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