Nifty Next 50 – what should you do with your investments?

The Nifty Next 50 houses the 50 top companies by market capitalisation, after the Nifty 50. This index caught the limelight over the past month for featuring a handful of the Adani group stocks. 

As we had pointed out a couple of weeks ago in our write-up on Adani stocks and index funds, the presence of a few shaky stocks in an index is not reason enough to exit it. But even before the Adani-fuelled upheaval, the Nifty Next 50’s once-outstanding performance was being eroded.

The Nifty Next 50 index forms part of Prime Funds, Prime ETFs, and different Prime Portfolios.

In our view, a call on an index needs to come from its performance, how it compares with other opportunities, and how it fits in a portfolio. We have been tracking the performance of the index for a few quarters and have studied the stock movements in the index and their impact on returns. Based on this, we are now changing our call on the Nifty Next 50 to a hold. That means, you can hold investments made so far but avoid investing further. 

This report contains:

• The reasons behind the dip in performance
• The changes in Prime Funds & Prime ETFs
• The changes in Prime Portfolios

Nifty Next 50 – explaining performance

The Nifty Next 50 was intended to be an index that delivered returns much higher than the Nifty 50 or the Nifty 100 and closer to the mid-cap market segment. It straddled the middle ground of picking up stocks that were rallying in the midcap basket, but it also caught the laggards from the Nifty 50. That made it an outperformer on the upside, poor at containing downsides, and high on volatility. That also means the index is essentially a high-PE index.

The Next 50’s rolling 1-year return has been slackening in performance over the past few years, just about keeping pace with the Nifty 50 and then underperforming in the past year. Still, going by its strong historical performance, its 5-year rolling return outperformance over the Nifty remained strong (4-8 percentage points of outperformance in the 2016 to 2020 rolling period and higher before that) up until 2020. It managed to stay marginally ahead of the Nifty 50 even up to 2021. That means those who had invested in this index and held for several years would still have beaten the Nifty 50. 

Against the Midcap 150, the mid-cap fueled market rally saw the Next 50 fall well behind in the past few years. While the Next 50 had earlier beaten the Midcap 150 with some amount of consistency – based on rolling 3-year returns (it outperformed the Midcap index about half the time on an average), the Nifty Midcap 150 has thoroughly trounced the Next 50 index since.

The sliding returns of the Nifty Next 50 especially over the past year has pushed it below both the Nifty 50 and the Nifty Midcap 150. The Next 50 has been trailing the Nifty 50 by a margin of 3-10 percentage points on a 1-year basis.

So, what has led to this kind of dip in performance? No, it’s not just the Adani stocks! It is the Next 50’s very structure that drove its earlier performance that is causing current underperformance.

We broke down the Next 50 and the Nifty 50’s composition over several years to understand this. Here are the top reasons that are causing the Next 50 to perform the way it has!

#1 High churn

Consider the two points below:

• For the Nifty 50, there has been 60 unique stocks in the last 5 years. About 41 stocks stayed common throughout the 5-year period.
• For the Nifty Next 50, there has been 104 unique stocks in the last 5 years. Only 16 stocks were common throughout the 5-year period

This data shows you the extent of churn the Next 50 sees. This throws the longevity of stocks in Nifty Next 50 into question as it reflects that too many stocks are underperforming - companies get removed due to underperformance rather quickly, as it hits their market capitalisation. Remember, Both the indices mentioned are market-cap based indices and stocks would exit if their market capitalisation fell due to price falls.

Further, it’s not easy for a stock to move up from the Nifty Next 50 into Nifty 50; the entry barrier to the Nifty 50 is high due to large number of high market cap companies with stability and leadership. That means the Next 50’s return needs to come from the performance of stocks that move into it from the mid-cap basket (Next 50 stocks were once mid-cap stocks). 

If a mid-cap stock entering the Next 50 has already lost steam (cannot move to the next phase of becoming a large cap), then it is not doing enough by way of performance. And if it underperforms, it cannot hope to be in the Next 50 for long. That means a stock may enter the Next 50 and simply stay put or underperform post and exit.

#2 A gateway-plus-recycle bin

The Nifty Next 50 is the gateway to Nifty 50 as well as a recycle bin to stocks exiting the Nifty 50. What if some of the companies entering Next 50 don’t make into Nifty 50? They may either stay in Next 50 itself or get out of it if they underperform.

A stock getting into the Nifty 50, from the Next 50, is basically a stock that is rallying. So all good there. You enjoy the returns in the Next 50 for a while, before it upgrades to the Nifty 50. But stocks that exit the Nifty 50 get pushed to the Next 50. Do remember that a stock exits the  Nifty 50 either because a better stock with larger market cap has replaced it or it has not done well and there might already be trouble brewing in the stock. Such troubled candidates that enter the Next 50 can spell havoc. Let us look at both the cases in the respective tables given below.

The stocks in the second table above have done little to help the Next 50’s returns; these were those exiting the Nifty 50 owing to performance issues and simply continued with losses. While this is par for the course given the index construction, the performers exiting the Next 50 combined with the several underperformers within the index weighed on returns. See the next point.

#3 Causing havoc before exiting

Stocks entering the Next 50 which turned out to be sedate performers or underperformers have also capped the index’s returns. Some came in from a move up from the Nifty Midcap 150. Several, though, directly entered into the index through IPOs and with many of these tanking post the IPO boom, the impact on returns was harder. 

The table below shows some stocks that entered the Next 50 and exited (as of October 2022) over the last 5 years - without moving to the Nifty 50. The ones entering and exiting the Next 50, without making into Nifty 50, seem to be significantly hurting performance, even as the stocks that exited with reasonable returns may not have made huge difference to the index’s performance. 

(Please note that some of the stocks listed here may re-enter the Next 50 ).

Now consider the IPOs. The table below shows the list of IPOs that directly debuted in the Next 50, only to entirely capitulate post listing. While some of these are set to exit the index in the rebalancing effective March 31^st, they have meanwhile wreaked a good bit of damage to returns.

We rarely see such huge hits in a large number of stocks in a short span, and then exiting in losses. It also did not help that the Next 50 had limited share of banking, a key sector outperformer over the past year, and a heavy weight to those such as FMCG and chemicals that have been flat. 

Returns have further eroded since the Adani group fiasco decimated the group’s stocks. The Next 50 holds Adani Transmission, Adani Green, and Adani Total Gas – apart from Ambuja Cements, which the Adani group took over. At the start of January, these stocks had a weight of about 9% in the Next 50 (14%, if ACC and Ambuja Cements are included). The precipitous fall of 50-60% shaved off close to 5% of returns for the Next 50. Though some of these are ticking up now, if they eventually get shunted out of the index, it will simply be a repeat of the poor performance explained in the previous point.
The semi-annual review of the index, which will be effective at the end of this month, will see some of the underperformers move out. For example, Bandhan Bank, Gland Pharma, Mphasis, Biocon India, and One97 Communications will exit the index. ABB India, Adani Wilmar, Canara Bank, Page Industries and Varun Beverages will move in.

Nifty Next 50 – what to do with your investments

Going by recent 1-month returns, the severe underperformance of the Next 50 against at least the Nifty 50 appears to be narrowing. This is partly driven by strong returns clocked by some index constituents such as GAIL and HAL, as well as minor gains by top index weights.

Even so, there are the following aspects to consider:

• The extent of the underperformance has been steep and recovery from here, to beat the Nifty 50 will still take time. If the underperforming stocks continue to remain in the index (as explained in point #3 above), returns may still be subdued against the Nifty 50.
• That the index is a high-PE one at a time when growth-style stocks are staying out of market limelight can also weigh on returns.
• For high returns, the Nifty Midcap 150 is a good alternative. On a rolling 3-year and 5-year basis, the Midcap 150 beats the Next 50 about 90% of the time. While the mid-cap segment is more volatile, given the Nifty Next 50’s current performance, it can well be a worthy compromise. This apart, the lower individual stock weights in the Midcap 150 will help limit the impact of underperformance that is plaguing the Next 50. The Midcap 150 will also capture the up-move of stocks making it to the Next 50. 

In order to avoid further opportunity loss, we are changing our call on the Nifty Next 50 to a hold. The action to be taken in each of our recommendations is as follows.

Prime Funds

We have ICICI Pru Nifty Next 50 and UTI Nifty Next 50, in the Equity Aggressive section. We have removed both from the Prime Funds list. Hold all investments made so far in the funds. Avoid increasing exposure here, which means you can stop any SIPs you have running. Instead, use the Motilal Oswal Nifty Midcap 150 index for fresh investments. For a less-volatile alternative, consider the Edelweiss Nifty LargeMidcap 250 index or the Motilal Oswal Nifty 500 index. All are part of Prime Funds. 

Prime ETFs

We have Nippon India ETF Nifty Next 50 Junior BeES, in the Equity High Risk section. We have removed this ETF from Prime ETFs. Hold all investments made so far, and stop any SIPs that are running. Use the Nippon India ETF Nifty Midcap 150 for fresh investments. There are no other quality ETFs available other than the Midcap 150; therefore, ensure that your exposure to the mid-cap space is within your risk level.

Prime Portfolios

The Nifty Next 50 index features in several of our portfolios. In some of these, in earlier reviews, we had already reduced weights to the index. We are now removing the index from the portfolios – but hold all investments made so far and don’t exit. Stop any running SIPs, and start it in the new replacement fund.

We have recommended changes specific to the requirements of that portfolio. In some cases, we have adjusted weights of the other funds in the portfolio and in others we have replaced the fund/ETF altogether. We’ll provide a more detailed explanation of the rationale behind the changes as part of our overall explanation in our next quarterly review that is due in April.

For now, you can click on the portfolio you are keen on or invested in, to know the action to be taken:

• 3-5 year portfolio: Replaced with Motilal Oswal Nifty Midcap 150 index fund. The action to be taken can be accessed here.
• Greater than 7 years portfolio: Replaced with Motilal Oswal Nifty 500 index fund. The action to be taken can be accessed here.
• US/Canada NRI portfolio: Replaced with ICICI Pru Nifty Midcap 150. The action to be taken can be accessed here.
• NRI ETF portfolio: Replaced with ICICI Pru Nifty IT ETF, besides adjusting weights to other portfolio constituents. The action to be taken can be accessed here.
• Passive ETF portfolio: Removed the Nippon India ETF Junior BeES, and adjusted weights to the other ETFs in the portfolio to accommodate. Use the new portfolio weights for any fresh investments or SIPs – don’t try to bring the current portfolio allocation in line with the changed portfolio. The action to be taken can be accessed here. 
• Passive index fund portfolio: Replaced with Motilal Oswal Nifty 500 index fund. The action to be taken can be accessed here.

The reason why our recommendation is a hold (and not a sell now) is simple. One, the high -valuation IPO stocks and the underperformers can exit with time leaving the index with better performers that are indeed emerging large-caps. Hence a sell is not required at a time when there is a chance for the index to auto correct itself. And it is likely doing such an auto clean now. If another slew of high-premium IPO stocks hit the index, then we might want to take a relook 😊 We will keep you posted if any further change is needed.

General disclosures & disclaimers