With over 7,000+ stocks listed on the Indian stock exchanges, namely the NSE and BSE, determining the performance of the Indian stock markets on any given day would be a daunting task.
Similarly, evaluating the performance of a mutual fund scheme, like one providing 13% returns in the past year, becomes challenging without a comparable benchmark. To address such issues, the concept of ‘Market Indices’ emerged.
What constitutes a market index?
Comparing a market index to a thermometer measuring body temperature, a market index serves as a barometer gauging the health of a country’s stock market.
A stock market index comprises a selection of stocks chosen based on predetermined characteristics such as market capitalisation, liquidity, and trading frequency. Notable examples in India include the Nifty 50, S&P BSE Sensex, and the Nifty IT Index, which mirror either the entire economy or specific sectors.
This solves the dilemma. Assessing a market’s performance on a given day becomes straightforward by observing the economy’s benchmark index, such as the Nifty 50 and Sensex in India. If these indices decline, it indicates a negative performance for the stock markets on that day.
Likewise, comparing the performance of a mutual fund scheme to a benchmark like the S&P BSE Sensex, which yielded 16% returns in the past year, reveals whether the scheme has underperformed or not.
Understanding the significance of market indices
Market indices offer several advantages, simplifying investors’ decision-making process:
a) Providing Information and Sentiment Analysis:
Market indices reflect overall stock market trends and sentiments, serving as indicators of an economy’s state or a specific sector’s health. Trends in these indices help investors gauge market optimism or pessimism and assess valuations relative to historical levels or peers.
b) Benchmarking:
Market indices act as benchmarks for investors and fund managers, facilitating performance comparison. Fund managers strive to outperform these benchmarks, justifying their fees, while investors gain a yardstick for evaluating fund performance.
c) Trading:
With the rise of Exchange Traded Funds (ETFs) and Index Funds, investors increasingly trade in various index funds, seeking cost-effective alternatives to achieving market-beating returns.
Stock Classification in India
Understanding how stocks are categorised based on market capitalisation is crucial.
Market Cap Category
• LargeCap – Rs 20,000 crore and above
• Mid-cap – Rs 5,000 crore to Rs 20,000 crore
• Small Cap – Rs 1,000 crore to Rs 5,000 crore
• Micro-cap – Below Rs 1,000 crore
Popular Indices in India
Several popular indices in India offer insights into different market segments:
a) The Nifty 50 Index:
Comprising the 50 largest stocks by market capitalisation, representing various sectors, this index serves as a benchmark for large-cap mutual fund schemes.
b) The Nifty Midcap 150 Index:
This index tracks the performance of 150 midcap companies and serves as a benchmark for midcap mutual fund schemes.
c) The Nifty Smallcap 250 Index:
Representing 250 smallcap companies, this index is used to gauge the market breadth and often serves as a benchmark for small-cap mutual fund schemes.
d) Sectoral Indices:
Various sectoral indices like Nifty IT, Nifty Bank, Nifty FMCG, and Nifty Pharma focus on specific industries, offering insights for sector-specific investment decisions.
Conclusion
Market indices have undeniably simplified investment decision-making by providing benchmarks for performance evaluation. While this guide provides a foundational understanding, exploring the intricacies of market indices further can enhance investors’ comprehension of stock market dynamics.
*The article is for information purposes only. This is not investment advice.
(The author is Vice President of Research, TejiMandi)
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
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