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Using mid-cap indices as an investment tool has "low utility", as constant rebalancing destroys their historical relevance, while exaggerated movements in select sectors and stocks and dominance of a few sectors or themes at most times erode the relevance of top-down earnings and valuation exercises, according to Kotak Institutional Equities (Kotak Securities). In a strategy report dated 19 September, Kotak argued that it saw low utility in using mid-cap indices as an investment tool, given their ‘mechanical’ and ‘restrictive’ nature. “Mechanical” because the index components can change frequently, and “restrictive” because its limited number of stocks can lead to an excessive concentration in one or a few sectors. "Top-down earnings and valuation exercises have little relevance given (1) frequent and constant changes to the composition of the indices, (2) dominance of one or a few sectors or themes at most times, and (3) exaggerated movements in sectors and stocks due to frequent emergence and demise of sentiment-driven popular ‘narratives’," said Kotak. Kotak underscored that mid-cap indices comprise 150 companies, selected based on their free-float market capitalisation. Because stock prices keep changing, the companies included in the index can also change frequently. As a result, there is little relevance to any meaningful historical comparisons or insights. Moreover, when investors become optimistic or pessimistic about a particular sector, that sector can become over- or under-represented in the index. Kotak further explained that the mechanical nature of mid-cap indices drives frequent changes to their composition. It underscored that only 46 stocks have been part of the Nifty Midcap 150 index consistently over FY22 to the first half of FY27, and as many as 275 unique stocks have been part of the Nifty Midcap 150 index over FY22-FY26. "The constant churn in the indices makes them irrelevant for any meaningful historical comparisons such as future earnings growth with historical earnings growth, and future multiples with historical multiples," Kotak said. The Nifty Midcap 150 has a limited number of stocks, which means a few sectors can have a disproportionately large impact on the index if the particular sector becomes popular with investors. Several stocks from that sector can enter the index at the same time, making the sector heavily influence the index's overall earnings growth and valuation. On the other hand, several sectors that may not be popular among investors at that time can be under-represented. Kotak highlighted that a small number of sectors have a major influence on the Nifty Midcap 150’s performance. In the six half-year periods when the index delivered positive returns over the past 10 half-year periods (1HFY22–2HFY26), the top three sectors contributed 34% to 152% of the index’s returns. It also noted that the sector composition changed frequently. As many as seven different sectors featured among the top three sectors by weight during these 10 half-year periods. Read all market-related news here Disclaimer: This article is for educational purposes only and does not constitute investment advice. The views and recommendations expressed are those of individual analysts or broking firms, not Mint. We advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and circumstances may vary. Catch all the Business News , Market News , Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates. Oops! Looks like you have exceeded the limit to bookmark the image. Remove some to bookmark this image.
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