Mutual Funds: Do you need to invest in passive funds based on ‘Total Market Index’ having 750 stocks?

When it comes to passive investing in India, most investors tend to stick with well-known large-cap index funds such as those based on the Nifty50. However, the landscape of passive funds has expanded considerably, now offering a wide range of options. You may already be familiar with indices like the Nifty50 or the Nifty Next50, but there are also others such as the Nifty100, LargeMidcap250, Midcap150, and Smallcap indices. Thematic and sectoral funds are also available, adding up to over 135 different schemes in the passive fund space.

Most of these index funds tend to focus on specific segments of the market, sectors, or factors. However, there is an intriguing option that aims to provide exposure across the entire market: the Total Market Index Fund. Let’s explore what this fund is, how it works, and whether it might be a worthwhile addition to your investment portfolio.

What is the Total Market Index Fund?

The Total Market Index Fund is based on the “Nifty Total Market Index,” launched by the National Stock Exchange (NSE). This index aims to track the performance of the top 750 stocks by market capitalization. Having 750 stocks in a single fund certainly seems appealing for diversification enthusiasts, but does it truly add value to your portfolio? Let’s dive deeper.

The 750 stocks included in this index come from a broad spectrum:

100 large-cap stocks from the Nifty100 (which includes the Nifty50 and Nifty Next50)
150 mid-cap stocks from the Nifty Midcap150
250 small-cap stocks that are part of the Nifty500
Stocks ranked 251 to 750 beyond the Nifty500, mostly comprising microcap stocks

Until recently, the closest option to the Total Market Index was the Nifty500, which covers the large-cap, mid-cap, and small-cap segments. However, the Nifty500 did not include any stocks from the microcap category beyond the top 500. The new Total Market Index fills this gap by including microcap stocks, theoretically offering broader diversification. But the question remains: does it genuinely enhance diversification, or is it just an “optical illusion” given the large number of stocks?

How Diversified Is the Total Market Index Fund?

The data from the NSE suggests that the Total Market Index is highly correlated with the Nifty50. Over a five-year period, the correlation between the two stands at a staggering 0.98, and for a one-year period, it is 0.95. This high correlation implies that the returns from the Total Market Index and the Nifty50 are likely to be very similar.

The primary reason for this similarity is that the Total Market Index is weighted by market capitalization. In other words, larger companies receive higher weights in the index. So, despite having 750 stocks, the fund does not provide equal exposure across all market caps (large, mid, small, and micro). It remains heavily skewed towards large-cap stocks in the top 100, with minimal exposure to small-caps and microcaps.

This is similar to why investing in a Nifty100 fund is not the same as investing in both the Nifty50 and Nifty Next50 separately. The higher weighting towards large-cap stocks means that even if you are buying into a fund with hundreds of stocks, a large portion of your investment is concentrated in just a few of the largest companies.

Should You Consider Investing in the Total Market Index Fund?

For investors who are already invested in passive funds tracking the Nifty50, Sensex, or Nifty Next50, adding the Total Market Index Fund to your portfolio might not offer significant benefits. You would essentially be gaining incremental exposure to stocks ranked 101 to 750, which is not substantial enough to impact overall returns meaningfully. If your portfolio already includes large-cap index funds covering the top 100 stocks, there isn’t a compelling need to add this new fund.

However, if you are new to passive investing and do not yet have any exposure to index funds, the Total Market Index Fund might be an interesting option to consider. It offers broad exposure to various market segments in a single fund, which can simplify your investment strategy.

How Does It Compare to the Nifty500?

Even if you are looking for diversification, a Nifty500 index fund could provide sufficient exposure to the Indian stock market’s usable universe. The Nifty500 Index Fund typically has about 72% in large-cap stocks, 17-18% in mid-cap stocks, and 10-11% in small-cap stocks. In contrast, the Total Market Index Fund, with its 750 stocks, has a similar distribution: 69% in large caps, 16-17% in mid-caps, and 13-14% in small and microcaps. The differences are relatively minor, making it a matter of preference whether to choose one over the other.

Final Thoughts

Investing in the Total Market Index Fund is a viable option if you prefer a single fund that covers a wide range of market segments. However, its high correlation with the Nifty50 and the heavy weighting towards large-cap stocks mean that it may not add significant diversification benefits if you already have exposure to other large-cap funds.

As always, consider your financial goals, risk tolerance, and investment horizon before making any decisions. Passive investing is about simplicity and long-term growth, so choose funds that align with your strategy rather than just chasing the latest offerings.

Disclaimer: The views expressed above are for general informational purposes only and do not constitute professional investment advice. Always consider your financial situation, risk profile, and consult with a financial advisor before making any investment decisions.