How smallcases are Created — A Deep Dive into Our Research
A smallcase is akin to an ETF wherein an index is created to measure & track a theme or strategy
Imagine a world without stock market indices–no Nifty and no Sensex. How would you keep track of the stock markets and measure its performance? How would you identify and select stocks to invest in? And how would you know whether your selected stocks or other equity-oriented investments are doing well or not?
This is primarily why Charles Dow & Edward Jones created the first index in 1884. Known as the Dow Jones Transportation Average, the index consisted of 11 stocks and its objective was to track the performance of the railroad/transportation sector (which was quite bustling with economic activity and investor interest back then). Not much later, they created the Dow Jones Industrial Average to track the performance of the major industries of the U.S. economy. Even today, after more than 120 years, this index remains a key indicator of the health of the U.S. economy!
At its simplest, an index is a tool that tracks the value of a particular market (e.g. real estate, gold, stocks) or market segment (e.g. midcap, IT sector). It is designed to represent an underlying group of securities and follows a consistent set of rules, i.e. the methodology. This allows investors to follow the trends of a specific group of companies, themes, sectors, or even countries without having to track every individual stock. If investors want to know which sector or country is doing well, all they have to do is look at the index value.
An index is a tool that allows investors to follow the trends of a specific group of companies, themes, sectors or even countries.
Every country has its own major indices that people follow–the Dow Jones and the S&P-500 in the U.S., the FTSE-100 in the U.K., the CAC-40 in France, the NIKKEI-225 in Japan, and of course our very own Nifty-50 and Sensex-30 in India. All these indices track the performance of a certain number of the largest companies in that country, thus forming an indicator of the economic health of that country. For example, the Nifty-50 tracks the performance of the 50 largest publicly listed companies in India.
Investing in indices
What an index also does is provide investors with a ready-made portfolio of securities that they can invest in. When a person invests in the Nifty-50, what they are effectively doing is investing some amount in each of the 50 largest Indian companies & tracking their performance. Investments that track an index are called “passive”, while those investments that deviate from their chosen/defined index are called “active”.
For example, all ETFs track the performance of some pre-defined index. On the other hand, most mutual funds tend to be “active” since their fund managers try to invest in a manner different from their benchmark index.
A smallcase investment is more akin to an ETF in this regard. Each smallcase has a defined objective–whether it is taking exposure to value stocks, the electric mobility theme, or a smart beta strategy. Once the objective has been identified, the smallcase Research Team creates an index of all stocks that fit that theme/strategy in order to measure & track its performance.
Similar to popular indices like Nifty or S&P-500, smallcase index constituents have a weightage and are rebalanced periodically. As such, when you invest in a smallcase, you are actually investing in an index that is designed to measure the performance of that particular theme, sector, or strategy and the index value is a measure of how it has performed since its creation–it’s like you have your very own & personalised quasi-ETF!
How is a smallcase created?
Since there are numerous themes and strategies to choose from, the first thing the research team evaluates is whether a theme has a large-enough investable universe to choose from, i.e. whether the theme has enough stocks to invest in. For example, even though many users have shown interest in a Green/Renewable Energy smallcase, we haven’t yet created one because there aren’t enough good listed companies that meet these criteria.
After this preliminary check, the smallcase Research Team sets out different rules based on the strategy or theme. To give you a better understanding, we have analysed the steps used to create the Dividend Aristocrats smallcase on our blog.
Read more on the smallcase research here.
Advantages of investing the smallcase way
When you invest in a smallcase, you are investing in an index that tracks a particular theme or strategy. The smallcase follows a systematic and rules-based approach that uses measurable data such as price, volatility, earnings, etc. and ignores any subjective opinions. This eliminates the effects of any biases, which impacts all investors including fund managers. In addition, a rules-driven strategy has no room to react to short-term news and events, keeping in mind just the long-term objective.
A smallcase follows a rules-driven strategy that has no room to react to short-term news and events, keeping in mind just the long-term objective.
Eliminating biases & emotions by harnessing the power of data is the key benefit of a systematic approach to investing. We follow this approach to leverage modern technology and to ensure that our research doesn’t suffer from any element of vague subjectivity.
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