Stock market indices in India are scorching a novel path. As the amp goes from hot to boiling, we are not referring to equity valuations, which in recent months have actually retreated. Indices, however, are quite a different story — their numbers, variety and followers are simply setting new records.

Never in the history of our stock market did so many invest so much on the basis of these metrics.

While traditional benchmarks such as Nifty and Sensex still remain popular, a genre of contemporary indices now fight for attention.

In fact, the growing acceptance of fresh yardsticks based on strategies and themes — as opposed to those drawn from old-school market capitalisation — underscores the changing preferences of our investors.

Take a look at the current basket of thematic and strategic categories, which cover a wide range of economic sectors, market trends and investment styles.

Some of the current business environment’s most appealing themes have given rise to smart indices based on electric vehicles (“new age automotive”, says National Stock Exchange), logistics, railways, defence and tourism.

Strategic indices offer a compelling vista too — investors can choose an array of factors such as volatility, beta, momentum and quality. These are known to be gradually gaining ground; the trend is likely to sustain in future as well.

Today’s column is not a primer on indices. We will instead go beyond the textbook and seek answers to three critical questions:

• How should investors construct their index playbook?
• Should old-style indices be bypassed and only the new ones considered for purposes of investment?
• How do investors stand to gain from the use of the so-called smart indices?

One answer at a time

Let’s take the posers one by one. The ideal indexing playbook may well be a mix of old and new metrics. Many investors will surely want the best of all categories. A Nifty 100 may well tango with a Nifty MidSmall 400 and a Nifty 200 Momentum 30. (See chart on new gen indices)

The idea is to derive optimum returns in the shortest span of time — isn’t that what most investors want? The avid indexer will, however, temper his aspiration with a fair bit of reality-check. Not all indices will perform equally well all the time. That is why we will need a factor-based approach along with a market-cap driven tactic.

Ergo, older indices may not be dumped altogether. It is widely felt that standards like the Nifty and the Sensex are true barometers of investor sentiments.

Many astute investors who adopt passive strategies (as opposed to active ones, where the very rationale is to beat the relevant benchmarks) are largely in favour of these standards even in this day and age. Pitching only on the basis of factor indices is not a viable concept for all.

The logic working in favour of specific themes, sectors and factors is well appreciated. One, some of these are based on modern and emerging businesses. We are already aware of the significance of railways, capital markets, mobility, non-cyclical consumption and energy in the current context

Two, it may be assumed that no investor will want to stay out of these areas for long. Indexing is generally considered an efficient and convenient way of entering such spaces. Three, as followers of indices will no doubt agree, there is an in-built cost efficiency — this is almost always a compelling rationale for investors.

The right plan

Investors who desire to build their edifice on a foundation of indices must work out a specific plan. We will mention its contours here.

• Choose an optimum mix of indices. There is great variety already on the index front, and there will be a lot more diversity in future. The correct blend of indices will make a difference.
• Set up systematic investment plans. Exchange traded funds and plain-vanilla index funds are available to serve investors. Many investors consider building their corpus with the help of medium and long-term SIPs.
• One-time allocations can be handy at the correct juncture. A sectoral index will obviously decline when the fortunes of the sector (that is valuations) on which it is based are retreating. A timely lumpsum allocation is likely to fetch sharp returns.
• Be aware of probable aberrations. Tracking errors are a fact of life, not every indexer can perfectly mirror his quarry. Such is the nature of the beast and even professional fund managers acknowledge this.

The last word goes to those who are set to begin their journey towards indexing. The mix you will choose should adequately reflect your risk-reward perceptions. We all want to create the most efficacious portfolio, one that stands the test of time.

That, however, is almost always an improbable ‘ask’ because the market has a mind of its own. It can upend your best laid plans, and astute indexing alone will not help you in dire situations.

So once you start your journey, be on your toes and do not let down your guard.

Monitor progress and rebalance as and when necessary. It is also important to be familiar with the latest developments related to indices.

Even as we write this, the nation’s premier exchange has announced a series of changes in its leading indices. Yes, such reshuffles are critical for all index adherents (See chart on reshuffles).

The writer is director, Wishlist Capital