Index funds invest in an index. But what are the different types of indices and index funds?
Indices can be of different types, like benchmark, broad market and sectoral. However, the index itself is a contribution of various sectors. Therefore, by investing in index funds, you invest in a predetermined sectoral composition. Let us look at two major components of benchmark indices: the banking sector and financial services sector in detail.
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Difference between Banking and Financial Services Companies
Sector Classification
The composition of financial services stocks in an index is more diverse compared to the narrower focus of banking stocks alone. Banking stocks fall within the financial sector and financial services span a broader spectrum encompassing not just traditional banks but also insurance companies, investment firms, payment processors and Real Estate Investment Trusts (REITs). Your index funds comprise of both these sectoral contributions.
Risk Profile
Banking stocks have a different risk profile compared to other financial services stocks. Banks are directly impacted by interest rate changes, regulatory changes, credit risk and macroeconomic factors that affect lending and borrowing activities. Other financial services stocks have different risk exposures related to market fluctuations, underwriting risks or investment management performance.
Business Models
Banking stocks derive revenue primarily from interest income (net interest margin), fees from services like loan origination and sometimes trading activities. Financial services stocks can have varied business models including collecting premiums (for insurers), managing assets (for asset managers) or earning fees from advisory services (for investment firms).
Regulatory Environment
Both banking and financial services stocks are subject to regulatory oversight but the specific regulations can vary. Banks are typically subject to stringent banking regulations that focus on capital adequacy, liquidity and risk management. The financial services companies on the other hand may be regulated differently based on their specific activities like insurance regulations, and investment regulations.
Characteristics of Private Banks, PSUs and Financial Services Stocks
| Particulars | Private Sector Undertakings | Public Sector Undertakings | Financial Services Stocks |
|---|---|---|---|
| Characteristics | These are privately owned financial institutions that operate with the primary goal of maximizing shareholder value. They are usually more agile and have a greater focus on profitability compared to public sector banks. | PSUs are government-owned banks where a majority stake (more than 50%) is held by the government. They play a crucial role in the economy by providing banking services across various sectors and regions often focusing on financial inclusion and government-directed lending. | These companies encompass a wide range of entities beyond traditional banks including insurance companies, asset management firms, brokerage firms, payment processors and diversified financial services providers. |
| Examples | HDFC Bank, Kotak Mahindra Bank and ICICI Bank | State Bank of India (SBI), Bank of Baroda, and Punjab National Bank | Life Insurance Corporation of India (Insurance company), Paytm (Payment processing and Fintech), Bajaj Finance (NBFC) and ICICI Prudential Asset Management Company (asset management) |
| Performance | Their performance is influenced by factors such as loan growth, interest rate changes, operational efficiency, and strategic initiatives. They often attract investor interest due to their potential for higher returns and growth. | Their performance is influenced by government policies, economic conditions, regulatory changes and their ability to manage non-performing assets (NPAs). They often face challenges related to bureaucracy, slower decision-making and political interference but can benefit from government support during economic downturns. | Their performance can be diverse depending on their specific sectors and business models. Factors influencing their performance include market conditions, regulatory changes, investment returns, fee income and technological advancements (especially in fintech). |
Number of benchmark indices at NSE and BSE
| Types of Indices | BSE | NSE |
|---|---|---|
| Broad market indices | 18 | 18 |
| Sustainability indices | 3 | 0 |
| Thematic indices | 6 | 35 |
| Strategy indices | 10 | 39 |
| Sectoral indices | 20 | 19 |
| Total | 57 | 111 |
(Source: https://niftyindices.com and BSE – Indices (bseindia.com)
Out of the total 20 sectoral indices in BSE, 2 constitute to banking and financial services stocks namely BSE Bankex, BSE Financial services and out of total 19 sectoral indices in NSE, 7 constitute to banking and financial services stocks namely Nifty Bank, Nifty Financial Service, Nifty Financial Service 25/50, Nifty Financial Service Ex Bank, Nifty Private Bank, Nifty PSU Bank and Nifty MidSmall Financial Service. Like indices, there are index funds available for investing in them.
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Banking, PSU and FS stocks in Broad market indices in India
Next up, let’s discuss the composition mirror for most index funds in India, the broad market indices. Broad market indices in India refer to indices that aim to represent the overall performance of the stock market by including a diversified set of large, actively traded companies across various sectors. The two main broad market indices in India are Nifty 50 (NSE) and Sensex (BSE). Investing in index funds in India generally comprises these benchmarks, and broad market indices.
Let’s understand the sectoral contribution of the banking and financial sector in these indices.
Private Bank Stocks
Prominent constituents of broad market indices like Nifty 50 and Sensex, reflecting their substantial market capitalization and sectoral influence. Private bank stocks have large market capitalizations and strong sectoral influence within the financial services industry. They collectively hold substantial weight in broad market indices due to their consistent earnings, growth potential, and investor confidence in their management and operational efficiency.
PSU Stocks
Primarily represented in sector-specific indices, focusing on public sector companies across various industries.
Financial Services Stocks
An integral part of both sector-specific and broad market indices, reflecting their diverse operations and economic significance. Financial services stocks collectively contribute significantly to broad market indices due to their diverse operations, strong financial performance, and integral role in India’s economic and market dynamics.
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Contribution in Benchmark Indices other than Broad market indices
PSU Stocks
They play a significant role in various benchmark indices, particularly those that specifically track PSU companies or sectors. Following is the breakdown of how PSU stocks are represented in some key benchmark indices:
1. Nifty PSU and BSE PSU Index
These indices specifically track PSU companies across various sectors such as oil & gas, power, financial services, utilities, metals & mining and others. It includes companies like NTPC, PGCIL, Bharat Electronics, Coal India, ONGC, PFC, REC, Indian Oil and others (NSE) and OIL, RITES, NMDC, GAIL, BPCL and others (BSE). The weightage of each stock in the PSU Index depends on its market capitalization and sectoral importance.
2. Nifty CPSE and BSE CPSE Index
The Central Public Sector Enterprises (CPSE) Index is another benchmark that includes major PSU companies. Nifty CPSE is constructed in order to facilitate Government of India’s initiative to disinvest some of its stake in selected CPSEs across different sectors like oil & gas, power, capital goods & construction and includes companies like NTPC, PGCIL, Bharat Electronics, Coal India, ONGC and others. BSE CPSE includes companies like RailTel Corp, Oil India, MTNL, RITES, IRFC, BHEL and others.
Private Bank Stocks
They are favoured by investors for their strong fundamentals, stable earnings, and growth prospects in India’s expanding financial sector. Their inclusion in these benchmark indices highlights their significance in the Indian stock market and their role in shaping market movements. Following is the breakdown of how Private bank stocks are represented in some key benchmark indices:
1. Nifty Bank
This index specifically tracks the performance of the banking sector in India. Private banks play a significant role in this index, with HDFC Bank, ICICI Bank, Axis Bank, and Kotak Mahindra Bank being key constituents. The Nifty Bank index reflects the performance of both private and public sector banks.
2. BSE Bankex
Also called BSE Banking Index, is designed to track the performance of major public and private sector banks listed on the BSE. It includes a mix of large, mid-sized, and sometimes smaller banking entities that are actively traded on the exchange. It includes leading banks such as State Bank of India (SBI), HDFC Bank, ICICI Bank, Axis Bank, and other prominent players in the banking sector.
3. BSE Private Banks Index
The BSE Private Banks Index is a subset of the broader BSE Bankex and focuses specifically on private sector banks listed on the BSE. It excludes public sector banks and includes only privately owned banks like HDFC Bank, ICICI Bank, Kotak Mahindra Bank, Axis Bank, and others that are known for their market leadership, innovation, and operational excellence in the private banking space.
Financial Services Stocks
They are crucial for diversification within indices, reflecting the substantial role these companies play in the Indian economy’s financial infrastructure. Their inclusion in benchmark indices provides investors with exposure to a key sector that drives economic growth and stability.
1. Nifty Financial Services Index
This index specifically tracks the performance of companies in the financial services sector. It includes banks, insurance companies, NBFCs (Non-Banking Financial Companies) and other financial institutions. The key constituents include HDFC, ICICI Bank, Bajaj Finance, SBI Life Insurance, Kotak Mahindra Bank etc.
2. BSE Financial Services Index
This Index serves as a benchmark to gauge the overall performance of the financial services sector in India. It provides investors and market participants with insights into the trends, volatility, and growth prospects of financial services companies listed on the BSE. Key constituents are Bajaj Holding, Bajaj Finance, Maharashtra Scooters, JSW Holdings, HDFC AMC, KFin technologies etc.
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Wrapping Up
Banking and financial services stocks majorly contribute to various indices and index funds. With their considerable contribution to various indices, their impact on index funds can be analysed. Furthermore, investing in index funds can also help investors manage the hassles of stock selection and portfolio micro-management.
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