General Electric or GE, the world’s biggest engineering company, will no longer be a part of the Dow Jones Industrial Average, the iconic barometer of the world’s capitalism. It was announced that Walgreens-Boots Alliance would replace GE, which was part of the original Dow index in 1896 and was never removed since 1907.
Yes, companies are moved in and out of benchmark indices over the years. The idea is to create a barometer for capital growth. After all, benchmark indices like Dow represent companies that represent sectors that form the engines of the economic growth. GE losing out to a healthcare company means core engineering no longer represents future growth.
In India, the 30-share BSE Sensex (now called S&P BSE Sensex) has been a benchmark for India’s economy since the launch in 1986. Last Monday, Dr Reddy’s Laboratories, a pharmaceutical company, was removed from the index.
It was replaced by Vedanta, the metal and mining giant.
This will double the weight of the metals industry in the benchmark index to 2.6 per cent and cut that of the pharma industry to 1.7 per cent of the index value.
Such changes are actively made by S&P that also manages the Dow Jones Industrial Average.
Changes to stock indices affect your investments. If you own index funds or exchange-traded funds (ETFs), their net asset value mirrors the performance of the S&P BSE Sensex. Since these are passively managed and are expected to track the performance of the benchmark, fund managers would have to sell the stock excluded and buy the stock included to the extent of the weight in the index. Mutual funds managing active index funds that are supposed to outperform the Sensex would have to make an adjustment too.
Over the past 10 years, as many as 18 stocks have remained unchanged in the 30-share Sensex, according to Motilal Oswal Securities analysis on these changes.
Why indices matter
Stock market indices are predominantly used by asset management companies to benchmark performance. If your mutual funds are investing in the stock market on your behalf, they have to do better than the Sensex or other index they consider a benchmark. There are several indices like the NSE Nifty and wider indices like S&P BSE 500 and NSE 500. Mutual funds typically create products that treat such indices as the benchmark.
The total assets under management of mutual funds exceed a staggering $43 trillion dollars. More than half of that is held by companies in the US. About 44 per cent of these are equity assets and they are all benchmarked to indices around the world.
In India, the total assets under managed hover around $300 billion (or `23 lakh crore). That is a fraction of the money managed in the world. A third of this money is invested in the equity or equity-linked funds. Unlike the world average of 62 per cent of GDP, the money invested through mutual funds is just about 13 per cent of India’s GDP.
As an ordinary investor, you may wonder about the importance of this. Over 30 years, the Sensex has given an average return of over 14 per cent. This is superior to returns from gold, real estate, fixed deposits and government savings schemes. It was well above the average inflation rate of 8 per cent.
So, if you have been a regular investor in a fund that simply tracks the S&P BSE Sensex, you could have created wealth for yourself. This is despite a very high inflation rate.
What can you do
If you are at a stage where you are contemplating investing in mutual funds or a strategy for investing in mutual funds, index funds or ETFs are a good way to start with. That way, you are testing waters and you actively know where your investment stands. Globally, ETFs account for 10-15 per cent of total assets under management, according to global industry body International Investment Funds Association. In India, only 3.4 per cent of the total money is in ETFs. Since their advent in 1990s, close to $1.7 trillion is invested in ETFs in the US. Their popularity rides on their simplicity. So, if you invest in an ETF, your investment grows in front of you. While these indices move up and down based on the daily market value, the 30-year performance shows that you can create wealth through passive investing.
(The author is a publisher and founder at Simplus Information Services Pvt. Ltd.)