SX-40 versus Sensex, Nifty

Last Updated: Mon, Feb 18, 2013 05:07 hrs

Since 1994, the trader has had the option of taking a position on either the traditional Bombay Stock Exchange (BSE) or the dominant National Stock Exchange (NSE). There are a 1000-odd stocks listed on both stock exchanges. Equity volumes are split about 85:15 in favour of NSE. In F&O, NSE corners the lion's share of futures volumes. But BSE does brisk business in index options.

Now, with the launch of the MCX-SX, a third trading platform enters the picture. The MCX SX listed after a highly successful IPO in 2012. It has useful antecedents. The promoters include Financial Technologies, which specialises in managing the IT needs of financial exchanges.

The MCX, which is another promoter, has an impressive track record in the commodities market, where it holds dominant marketshare versus the NCDEX. The MCX has also competed head-to-head successfully versus the NSE in the fast-growth currency derivatives market. The BSE doesn't offer currency derivatives. Competition is good for customers. The presence of a third player would ideally force innovation, rather than lead to price wars between brokerages. It may take a while though before MCX-SX starts generating meaningful volumes, given entrenched opposition in equity and F&O. Like all ambitious stock exchanges, the MCX-SX has launched its own benchmark index, the SX-40, which tracks 40 of the largest companies listed on the new exchange.

As the exchange gains market share, the SX40 will attract more interest. It is likely to become a benchmark for the mutual fund and ETF industries. That has interesting implications. Index funds and ETFs tracking the SX-40 will have to buy its constituent shares in the same weights. If an active diversified fund benchmarks its portfolio versus the SX-40, the portfolio will reflect that index's peculiarities. If derivatives based on the SX-40 develop high volumes in the F&O segment, the slightly different characteristics of the new index could also prove important. So we now have three major indices to track. It's interesting to compare them and make a guess at future differences in performance. All three use the same methodology of assigning weights by free-float market capitalisation.

The 30-stock Sensex is the narrowest and oldest with a base year of 1983-84. The Sensex has just one scrip, Sterlite, which is not included in the broadest of the three indices, the 50-share Nifty. It has just two scrips, Sterlite and SBI, which are not part of the SX40. The correlation between the Nifty and the Sensex is close to 1. Sensex and Nifty almost always move in the same direction. In effect, you could buy the Sensex or the Nifty and get almost the same returns. The risk of holding the more diversified Nifty is a little less and the Nifty has yielded higher return than the Sensex in the past three years, while having less of a drawdown during the bearish period of 2011-12.

The SX-40 holds three stocks absent from both the Sensex and the Nifty and of course, it doesn't hold 13 stocks that are part of the Nifty. The three SX-40 stocks absent from both Sensex and Nifty are Titan, United Spirits and Zee Entertainment.

All three stocks are part of the Junior Nifty, the second-rung 50 stock index computed by the NSE. These three stocks have been major success stories in terms of capital appreciation since the SX-40 base year of 2010-11. Titan has been a multi-bagger gaining almost 300 per cent. ZEEL is up about 70 per cent and McDowells up about 40 per cent. This trio is part of the reason why the back-calculated SX-40 is an outperformer versus both the Sensex and Nifty. The SX-40 has returned 16 per cent over 2010-13 against the Nifty's 15 per cent and the Sensex's 13.5 per cent. The correlation of the new index with its older cousins is also high.

The SX-40 has higher sectoral exposure to Consumer Goods and Consumer Services than either Sensex or Nifty – the trio mentioned above, for instance, are in those spaces. Due to the exclusion of SBI, Axis Bank, BoBaroda, IDFC. Kotak Mahindra and PNB, the SX-40 has lower weightage for Financials at 22 per cent, compared to the Nifty (29.4) or Sensex (26.4). However financials still form the largest sector exposure for the SX-40. The performance of stocks and sectors change over time.

Broadly, the SX-40 will be less affected by movements in financials and more by changes in consumer spaces. The historic performance and the weights imply the new benchmark could be an outperformer in a high-interest rate regime. If rates are falling however, it may be an underperformer, unless the consumer segments yield returns comparable to financials.

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