2.1.16 Stock Indices

A standard basket, not a single stock

An index is built from a defined set of stocks selected and weighted by rules, most commonly by company size. The Nifty 50 tracks the 50 largest, most liquid companies listed on the National Stock Exchange, while the Sensex tracks 30 large companies on the Bombay Stock Exchange. When someone says the market was up 1% today, they usually mean one of these indices moved by that much.

Both headline indices are free-float market-cap weighted, meaning larger companies exert proportionally more influence on the index level. Beyond them, India has a wide range of indices: the Nifty Next 50, Nifty Midcap 150, Nifty Smallcap 250 and Nifty 500 capture different slices of the market, while sector indices like Nifty Bank, Nifty IT and Nifty Pharma track single industries. A year when the Nifty 50 rises 10% might see small caps rise 25% or fall 15%, which is why the headline index alone does not represent the whole market.

Why indices matter for investors

An index gives a fair, transparent reference point for judging any actively managed fund's performance. If a large cap equity fund returns 11% in a year while the Nifty 50 returned 13%, that fund has underperformed its natural benchmark for that period, regardless of how good 11% might sound in isolation without that comparison.

One detail matters here: the proper benchmark is the Total Returns Index, which includes dividends reinvested, not the price index that scrolls across news tickers. The TRI runs roughly 1-1.5% higher per year, and a fund that reports outperformance against the price index but lags the TRI is not actually beating the market. Indices are also self-cleaning: the Nifty 50 periodically drops companies that fall in size and adds ones that have grown, quietly removing its own laggards in a way a static buy-and-hold portfolio does not.

Index funds and the alternative

Because indices are transparent and rules-based, funds can be built to simply replicate one at very low cost. These index funds do not try to beat the market; they try to match it as closely as possible. The consistent evidence that most actively managed funds fail to beat their benchmark after fees, over long periods, is the central argument behind the growth of index investing.

In India, expense ratios for Nifty 50 index funds have fallen below 0.10% for several options, making broad-market exposure extremely cheap. The choice between an index fund and an active fund for a given allocation comes down to whether you believe the active manager will generate enough alpha to justify the higher fee, net of taxes and tracking error. The rise of passive investing has turned these indices from pure measurement tools into major investment vehicles in their own right.