Vasanth
Jul 10th, 2015
Custom Indices
In our previous article, we discussed benchmarks in detail and acquainted ourselves with the concept of custom indices. Let’s discuss custom indices in some detail now. Although there are many ready-made/standard indices available on stock exchanges, they might not always fulfil investor’s need. Hence investors might want to build their own custom indices.
Suppose you believe that it is the right time to invest in pharmaceutical companies and want to buy select companies in the sector. The smallcase platform makes available a basket/smallcase/index called Pharmacase that allows you to take position in representative group of companies from the pharma sector. Pharmacase consists of 5 stocks (AA,BB,CC,DD,EE) and has an equal weighting scheme. We know that in an equal weighting scheme, all stocks in the portfolio have equal weights; hence each stock in Pharmacase has a weight of 20%. However being a prudent investor you have done your research and believe that stocks BB and DD will perform better than other stocks in Pharmacase and you want to assign higher weights to these stocks. Your preference is to allocate 35% weight each to BB & DD and distribute the remaining 30% weight amongst the remaining 3 stocks. Please refer to our article on index to refresh your understanding about weights and weighting schemes.
So you now customize the index by assigning higher weights to stocks BB & DD and also decide to use Pharmacase as your benchmark. Assuming a total investment of Rs.100 and price of each stock to be Rs.10, the below table illustrates how the value of your portfolio will change, relative to the value of Pharmacase, if only prices of stocks BB and DD rise by Rs.1 after one day.
Pharmacase, Investment Day
| Stock (A) | Price (B) | No. of Shares (C) | Weight (D=B*C/Sum[B*C]) | Value of Investment (E=D*100) |
|---|---|---|---|---|
| AA | 10 | 2 | 20.0% | 20.0 |
| BB | 10 | 2 | 20.0% | 20.0 |
| CC | 10 | 2 | 20.0% | 20.0 |
| DD | 10 | 2 | 20.0% | 20.0 |
| EE | 10 | 2 | 20.0% | 20.0 |
| Total | 100 =sum(B*C) | 100% | 100.0 |
Pharmacase, Investment Day +1
| Stock (A) | Price (B) | No. of Shares (C) | Weight (D=B*C/sum[B*C]) | Value of Investment (E=B*C) |
|---|---|---|---|---|
| AA | 10 | 2 | 19.2% | 20.0 |
| BB | 11 | 2 | 21.2% | 22.0 |
| CC | 10 | 2 | 19.2% | 20.0 |
| DD | 11 | 2 | 21.2% | 22.0 |
| EE | 10 | 2 | 19.2% | 20.0 |
| Total | 104 =sum(B*C) | 100% | 104.0 |
Custom Index, Investment Day
| Stock (A) | Price (B) | No. of Shares (C=D*100/B) | Weight (D) | Value of Investment (E=B*C) |
|---|---|---|---|---|
| AA | 10 | 1 | 10.0% | 10.0 |
| BB | 10 | 3.5 | 35.0% | 35.0 |
| CC | 10 | 1 | 10.0% | 10.0 |
| DD | 10 | 3.5 | 35.0% | 35.0 |
| EE | 10 | 1 | 10.0% | 10.0 |
| Total | 100 =sum(B*C) | 100% | 100.0 |
Custom Index, Investment Day +1
| Stock (A) | Price (B) | No. of Shares (C=D*100/B) | Weight (D) | Value of Investment (E=B*C) |
|---|---|---|---|---|
| AA | 10 | 1 | 9.3% | 10.0 |
| BB | 11 | 3.5 | 36.0% | 38.5 |
| CC | 10 | 1 | 9.3% | 10.0 |
| DD | 11 | 3.5 | 36.0% | 38.5 |
| EE | 10 | 1 | 9.3% | 10.0 |
| Total | 107 =sum(B*C) | 100% | 107.0 |
As can be seen from the calculations above, had you followed the trend and invested in Pharmacase, at the end of day 1 you would have ended up with Rs.104. But by customizing the index, you ended day 1 with Rs.107. You outperformed the benchmark by 3% (7%-4%). Your choices made you richer by an additional 3%. In just a few clicks, you can create and customise your own index on Smallcase. Power lies in your hand, use it wisely.
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