Financialisation of India: The Macro-Economic Trend Fueling Your Portfolio

As more individuals invest through mutual funds, SIPs, equities, and other financial products, the customer base for capital market participants may expand. This could create potential opportunities for:

• Higher transaction volumes

• Increased assets under management (AUM), and

• Greater demand for investment-related services

Besides, it can lead to “expansion” of investor accounts (such as demat accounts, mutual fund folios, and trading accounts) and increase the demand for financial services. All these factors may potentially lead to more business opportunities and improve the profitability of the following businesses:

• Stock exchanges

• Depositories

• Stockbroking firms

• Asset management companies (AMCs)

• Registrar and transfer agents (RTAs), and

Other market infrastructure providers
 

Investors who wish to potentially benefit from the “trend of financialisation” may consider investing in companies that are a part of India's capital markets sector. One way to participate is through “direct equity investing”, where investors:

• Research individual companiesand

• Build a portfolio based on their personal assessment of future growth prospects of the companies.

However, identifying the right companies requires time, research, and the ability to evaluate business fundamentals and market valuations. Investors who lack the expertise to analyse individual stocks may prefer investing through a Nifty Capital Market based Fund. 

To an investor, it may offer exposure to the “capital market theme” without having to select and monitor individual stocks themselves.
 

A Nifty Capital Market Fund is an index mutual fund / ETF that invests at least 95% of its total assets in the tracked/replicated Nifty Capital Markets Index. For those unaware, the Nifty Capital Markets Index tracks the 20 largest stocks representing the “capital market theme” from the Nifty 500 universe. 

These 20 stocks are selected based on 6-month average free-float market capitalisation, and the index is re-balanced ”semi-annually”. 
(Source: Nifty Indices, Factsheet of Nifty Capital Markets Index)

It is important to note that, like all passive funds, a Nifty Capital Market Index Fund / ETF does not aim to outperform its underlying benchmark index. Instead, it follows a “passive” investment strategy and replicates the index constituents by:

• Investing in the same companies and

• In the same proportions as the index it tracks.

Consequently, the its performance may mirror the performance of its benchmark index, subject to tracking error. 
 

A Nifty Capital Market Index Fund / ETF carries high “concentration risk”, as the fund invests only in companies that are part of India’s capital markets theme. Unlike diversified equity funds that spread investments across multiple sectors (such as banking, IT, or healthcare), this fund invests atleast 95% of its total assets in a single theme, that is, “Capital Markets”. 

As a result, its performance is heavily dependent on the growth of the capital markets sector. The NAV (Net Asset Value) of a Nifty Capital Market based Fund may potentially increase more sharply compared to diversified equity funds during periods of:

• Increasing financialisation of household savings 

• Strong market participation

• Rising SIP inflows

• Higher trading volumes

• Expansion of investor accounts, and more

In such favourable market conditions, the concentrated exposure to financial intermediaries can work as an advantage. However, the same concentration risk also works on the “downside”. The NAV of a Nifty Capital Market based Fund may fall more than diversified equity funds during periods of:

• Market slowdown

• Weak investor participation

• Falling equity markets, or

• Reduced trading volumes

In such phases, the companies operating in the capital market segment may underperform. Thus, investors should carefully assess their risk appetite and investment objectives before investing. 
 

So now you know what financialisation of savings is and which sector it may potentially support. If we were to revise, financialisation refers to the migration of household savings from traditional instruments such as commodities and real estate to financial products such as mutual funds, stocks, pension funds, and other market-linked instruments. 

Such a shift potentially benefits the capital markets sector. Increasing financialisation may improve the revenue potential and profitability of companies operating in the financial services segment, such as:

• Stock brokers

• Asset management companies (AMCs)

• Stock exchanges

• Depositories, registrars, and other market infrastructure providers, etc.

As an investor, you can potentially benefit from this macro trend by gaining exposure to the capital markets theme. This can be done in two ways:

1. Direct equity investing: You select individual companies after conducting your own market research and analysis.

2. Mutual fund route: You may invest in the Nifty Capital Market based Fund that invests at least 95% of its total assets in companies tracked by the Nifty Capital Market Index.

The “right” choice? It depends on your market knowledge, ability to time the market, risk tolerance limit, and investment objectives.
 

1. What is the primary risk of investing in a Nifty Capital Market Index Fund / ETF ?

A Nifty Capital Markets based Fund carries high “concentration risk” as the fund invests at least 95% of its total assets in the capital markets theme. If this sector underperforms due to low market activity or weak investor sentiment, the NAV of the fund may fall more than that of diversified equity funds.

2. Is a Nifty Capital Market Index Fund / ETF suitable as a “core portfolio” investment?

Realise that a Nifty Capital Market Index Fund / ETF is “sector-focused” with high concentration in financial market-related companies such as brokers, AMCs, and exchanges. As per general market understanding, this index fund / ETF is more cyclical and volatile compared to broadly diversified equity funds.

Thus, several investors potentially make a “satellite investment” in the Nifty Capital Market Index Fund / ETF. The core portfolio is usually built by investing in diversified equity index funds or multi-sector equity funds, which spread risk across different parts of the economy.