FLIP (Q & A) – updated 28th May 2018

Q1. How the daily index movement is calculated? Is it by averaging the movement of
top 30 or 50 companies? How it is calculated?

A1. Hello Sir, 

Daily Free Float market cap. of each of the top 30 (sensex) or top 50 (nifty) is
calculated and then divided by a divisor. Divisor can by different numbers for
different indices. For example, if today Total FREE FLOAT MARKET CAP of the NIFTY is
100,000, then we can divide the number by say 10, then NIFTY will be at 10,000.
Hope this helps. 

*Free float market cap = No of shares trading in the market (NOT the promoters
holding) * price of 1 stock of the company. 

We hope this answers your questions, please feel free to ask more. 

Q2. Can u tell me how divisor value is decided? And is it fixed all the time?

A2. Hello Sir,

For example we want to start a new index today , "EIFS - India" which will comprise of
only 3 companies, Say company A has 1000 shares worth INR 100 each. Company B
has 500 shares worth INR 50 each. Company C has 200 shares worth INR 80 each.
Market cap of these companies would be as follows:

Comp A - 1000*100= 1,00,000.

Comp B - 500 * 50 = 25,000.

Comp C - 200* 80= 16,000.

Now there is also a concept know as free float market capitalization which was I
think introduced somewhere in 2003. Say 20% shares of comp A are held by
promoters. So we consider the market cap of only the 80% shares that are freely
floating in the market, and 0.8 is called the free float factor and used to calculate the
free float market capitalization. Let us assume free float factor 0.8 , 0.5 and 0.4 for
comp A ,B and C respectively.

So the free float market capitalization for A,B and C would be

1000*100*0.8 = 80,000,

500*50*0.5=12,500,

200*80*0.4=6,400, respectively.

Total free float market capitalization would be 80,000+12,500+6,400=98,900.

Now if I am starting an index, say I want it to start with 100 just for simplicity. So
98,900 would represent 100. After say 10 years say the prices of stock A, B and C go
up to 200, 75 and 104 Respectively. Assuming Number of stocks and Free float factor
remains same. Then the new free float market capitalization would be:

Comp A- 1000*200*0.8= 1,60,000.

Comp B - 500*75*0.5=18,750.

Comp C- 200*104*0.4=8,320.

Total free float M. Cap would be 1,87,070.

Mcap of 98,900 = Index at 100

Mcap of 1,87,070 = Index at X?

Where X = 1,87,070* (100/98900) = 189. So the index value would be 189 And the
divisor would be (100/98900).

The divisor does not change frequently at all. Hope that helps. Please feel free to ask
any questions.

Q3. Hi Varun, I have a questions where you mentioned investment for more than 60
years in index funds.

1. Don’t you think 30 companies (in case of Sensex) are not sufficient to show the
picture of India's economy after few decades? This is when India is growing and in
best case there could be hundreds of big market capitalized companies, which will
not fit in top 30.

2. I don’t know if stock exchanges are private ltd companies. If they are, can they get
shutdown or bankrupt in 60 years long period. If it happens then what will happen to
the index funds, which are based on those indexes?

A3. Hello Sir, thank you posting your question. It's a great question and we apologise
for the late reply

1. NIFTY should actually reflect the economy even more realistically and accurately in
the future since usually what happens when an economy grows is that the
unorganised sector is slowly taken up by the organised sector. so the top 50
companies should actually end up reflecting more of the economy than they do
today. 

2. Sir, it doesn't really matter whether the stock exchanges themselves are private or
not, because you are simply investing in an index fund. So if the stock exchange goes
bankrupt, another one will be setup where stocks can trade and daily prices can be
reflected from the trading, which can help us make an index of top 50 companies.
Also, your money is invested in actual shares of the top 50 companies so nothing to
worry about if a stock exchange goes bust. Some top 50 companies will exist 60
years from today and they will likely be doing better than they are doing today. 

Q4. What is the difference between growth plan and dividend reinvestment Mutual
Fund plan ?
A4. Hello Sir, 

Growth is more tax efficient since the dividend is directly added in the fund NAV. In
dividend re-investment option, the Mutual fund company declares a dividend first
and then employs that money to buy more units of the fund, which get added to
your total no of units. Because now there is a tax on capital gains and tax on
dividend. Dividend re-investment is almost pointless. If you want your money re-
invested choose growth option only. 

Q5. Which is the best ? Sensex fund or Nifty fund? Why? Why varun sir has not
mentioned anything about Sensex fund? In which fund we can get max Return ?
Sensex or nifty50?

A5. Both Sensex and Nifty are the same for our purpose. Results of both are the
same since the first 30 companies, which are the 30 biggest companies are common
in both. NIFTY provides better diversification in a sense but for us, both are the
same. 

Also, NIFTY index funds are more commonly available than Sensex. Nothing wrong in
investing in SENSEX funds either. Whatever you choose, choose the one with the
lowest expense ratio 

Q5. When we compare ETF vs Direct index fund, than which one is better?

A5. Index funds are slightly more superior although both ETF and index funds both
serve the same purpose when they replicate nifty. 

1. Index funds don’t charge brokerage compared with ETF's, which need to be
bought and sold like stocks so brokerage has to be paid.

2. Index funds do not incur Securities Transactions tax (STT).

3. Index Funds do not have liquidity risk because when you want to redeem your
units in the fund, the fund company will purchase directly from you. When you sell
ETF's, you will need a buyer at the other end just like for a stock. In times of crisis you
may or may not find a buyer for your ETF.

In conclusion, index funds are more convenient and cheaper. 

Q6. Why there is a difference in returns of Different Mutual fund companies nifty
index fund? When returns should replicate NIFTY Index

A7. Great Question,

Returns can be different depending on the time the fund started and at what level
NIFTY was at the time. Over time, however, since you will be doing SIP, the result will
average out to 14-17% in the LONG TERM. 

Also, results are shown for Lumpsum NOT for SIP. SIP returns are slightly higher
than those shown. 
Another reason for difference is some funds show including dividend of 1-2%. some
don't and also if a fund is charging 0.5% (expense ratio) as compared to 0.1%, their
results will also differ over time. That's why we say choose the fund with the lowest
expense ratio (management fee)

THINK about this, KOTAK NIFTY FUND has returned 25% since inception. What's the
catch?

Q6. Do I need to open a Demat Account for investing in Index Fund?

A7. Good Morning sir,

Demat account is not required for investing in index funds. 

You can simply go to the Asset Management company's office and transact directly

with them without having a Demat account. 

Demat account is required to buy/sell shares individually or to buy/sell ETF's

(Exchange traded funds). 

Q7. What happens if the fund house (say UTI MF or ICICI MF) goes bankrupt or closes
down? What happens to mutual fund Investor? Has it ever happened in the past?

A7. Great question. 

In case of an index fund, since you are invested in the top 50 companies indirectly,
your money is still directly invested in the top 50 companies. The AMC/MF acts as a
fiduciary and are mandated to invest only in the Top 50 companies so even in the
case of the AMC closing down, your money should be safe. 

Mutual funds schemes have definitely shut down and quite often. Whether a
AMC/MF has shut down/become bankrupt needs a little more research. 

Q8. Sir nifty PE is about 25 (above the average level) but last 3 year earning is low.is
this a good time to invest lump some in nifty index.

A8. Great Question Sir, 

No we will not take any action without understanding Dow theory in the 4th session. 

When we have a situation when: 

PE Low, Earnings Low - Perfect Buy

PE high, Earning low - Dow theory 

PE high, Earning High - DO not Buy. 

PE low, Earning high - Buy (in most cases, unless we know for sure earnings will not
sustain)
What is Low and high, you've understood and you've understood earnings analysis.
Now, in Dow theory we will learn what to do when things are not Black or white.

For example, today PE ratio of 25 (For example) but what if it never comes down to
12 or 15 for the next 10 years? We will be left out of the market. So, we use Dow
theory to assess when to get in and when to get out when PE ratio is not a clear
indicator.

Q9. Can we apply DOW theory to sector indices... If so kindly brief note on what
should be the PE range?

Dow Theory must not be applied on Sectors. Only on NIFTY. 

WHY

1. The volatility in NIFTY is Lower as compared to Sectors. Dow theory can give false
signals if you apply on sectors and stocks. Must be avoided. 

2. Because Earnings for Nifty are much more stable than a sector or a stock, PE Ratio
range can be easily and more reliably defined. For example, NIFTY has oscillated
between 10 and 40 for the last 3-4 decades whereas in sectors, realty has gone up to
134, IT up to multiples of 100 etc. Therefore, because earnings are harder to predict
so application of Dow theory on Sectors can lead to false signals and is not a reliable
way to invest. 

Q10. Will using SIP approach work on stocks selected per identification criteria. Let's

we identify 10 stocks and invest am equal amount in them monthly and top up when

significant bottoms are identified. Will this approach not yield better returns than

doing SIP in NIFTY? If yes, why can't we use this approach for our important goals

instead of depending on index?

Rule No 1: Protect you capital. NIFTY cannot go to zero. Companies can go to zero.
Also, if you just simply increase the SIP amount or invest Lumpsum when NIFTY is in
the lower range, you'll beat the market anyway. The issue is such chances, arrive
rarely. Last one was in 2014. Also, just because a company is good doesn’t mean you
should invest in it at any price (See Individual stocks videos) so blindly just investing
in a stock because the company is great makes little sense.

Secondly, DOW theory (as taught by Mr. Malhotra) is a combination of Technical and
fundamental analysis where again, protection is capital has been kept as first priority
when defining the rules. The rules ensure (30 days and 4%) that we are able to
distinguish signal from noise. Such rules fail to hold consistently when applied on
stocks.

Lastly, earnings and PE range are way more unpredictable for stocks than for Index.
And that's why applying Dow on stocks and sectors can lead to false signals. 
As for beating the market, this is what Warren Buffett has to say " An ordinary result
over a long period of time, leads to an extra ordinary outcome".

We all want to beat the market and some years we will and some years we won't. But
the years we don't we want to ensure that we don't get wiped out because of taking
unnecessary risk.