Is it the Right Time To Invest in Index Funds?

Nifty 50 and Sensex are the two-most popular Indices in India for tracking equity market benchmark performance. Further, the index comprises of blue-chip stocks and various market leaders in India Inc. Therefore, an investor might look to own all stocks constituting the index through investment in Index funds rather than owning individual stocks. This will also enable portfolio diversification with exposure to various industries.

However, Index investing is not a particularly popular investment mode in India, as many market pundits believe it does not provide favourable risk-adjusted returns. The argument holds water in a bull market as the quality names which are part of Index would be trading at extremely premium valuations at most point in time. However, where index Investing may work is during environment like we are currently witnessing. As the correction continues further, almost all the quality businesses will be available at good bargains and it may not possible for investor to gain exposure to all the quality stocks. Index Investing might work just well here.

To be sure, Nifty generated returns of 14.4% CAGR from November 2008 (post global economic meltdown) to January 2020. However, if one moved up the timelines and calculates return from January 2008 when Nifty 50 was trading at peak levels of around 6,300 then the returns would have been merely 5.5%. Therefore, like in case of stock investment where entry point is important, even in Index Investing entry point is very important.

Basis above data it is clear that investing in Index funds posts crisis certainly generated superior returns. To identify the right entry point, an investor can look at metrics such as P/E (Price to Earning) and the valuations of the underlying securities to understand the state of the market

Source: NSE Website

The above data states the fairly obvious point that if the investor is able to time his entry at lower P/E multiples, then he will able to generate higher double digit returns from the market. Post the 2008 global economic meltdown, the P/E multiple of Nifty 50 Index had touched 12.4X leading to return of 14.4% on CAGR basis for people who invested during the period. Similar illustrations have been shown for August 2013 and February 2015

To keep things simple, an investor may check the P/E multiple of the Index and make his investment decision. As of 18 March 2020, the P/E of the Nifty 50 Index is at ~19X despite the steep correction during the last few weeks. Therefore, the investor may wait on the sidelines for few more trading sessions before starting to investing in Nifty 50 Funds. Alternatively, an investor may also start accumulating from current levels.

Why is Nifty 50 Index trading at high multiple of 19X despite the steep correction

The NSE website calculates the P/E data on standalone numbers and not on consolidated numbers. Therefore, this leads to higher P/E for the Index, as the P/E multiple for holding companies is very high on standalone basis. For example, the P/E for Bajaj Finserv on standalone basis is 286X, which is a absurd number. But, it would yet be used for calculation anyways, thereby bumping up the number.

Even on consolidated basis, some of the companies continue to enjoy premium valuations despite the market correction as indicated in the table below.

Source: Company Filings, MoneyControl

Therefore, there is still scope for further correction for many companies. In the last phase of the correction, there is a possibility that even the market leaders (Bajaj Finance, HDFC Bank, ICICI Bank, Asian Paints, Nestle India, Ultratech Cement, TCS) in the equity space will also witness substantial correction. This will provide the most opportune moment for long-term investors to invest in Index Funds

To Conclude……..

Investors may wait for further 10% correction before investing in Index Funds which will happen only when the quality names such as Nestle India, HDFC Bank, Bajaj Finance, etc. also witness substantial market correction. Post 10% correction, the Nifty 50 Index would be at P/E multiple of 17-18X (on standalone basis), which we believe is a favourable entry point to generate good long-term returns.

DO NOT PANIC. HAPPY INVESTING!