Broad based index
Also written Broad market index
A stock index representing an entire market segment and a significant share of that market — e.g. NIFTY 500 — used as the practical proxy for the market portfolio and as a benchmark for equity funds.
In plain language
An index can track fifty large companies, one sector, or one investment style. A broad based index tries to track the market as a whole.
The workbook's definition: broad market indices represent an entire market segment and typically represent a significant percentage of the selected market — for example NIFTY 500. Its footnote puts numbers on "significant": the NIFTY 500 represented about 96.1% of the free float market capitalisation of stocks listed on NSE as on March 29, 2019, and the Russell 3000 — the largest 3,000 US stocks — about 98% of the US equity market.
Broad based indices matter far beyond index-watching. They are what the rest of the course uses when it needs a number for "the market".
How it works
Three jobs the workbook gives them.
1. Proxy for the market portfolio (Chapters 3 and 8). The theoretical market portfolio includes every risky asset worldwide and cannot be built, so broad based equity market indices are often used as the proxy. There is no unanimity on which proxy to use, and an incorrect proxy affects both beta and the position and slope of the SML.
2. Reference point for beta (Chapters 4 and 10). Beta measures the change in a fund's returns caused by a change in the returns on a broad-based index. A market-neutral Category III AIF is neutral to the broad-based market index, so its beta is zero or close to zero; directional and short-bias strategies take net positions in stocks or a broad-based index.
3. Benchmark for AIFs (Chapter 8). Because AIF strategies vary so much, it is hard to build a benchmark for every category, so the manager can benchmark against a broad-market index matching the market-cap of the fund's holdings — indices published by NSE and BSE — as an indicative, if not perfect, benchmark.
Where it stops. Absolute-return strategies are not benchmarked against a broad-based index; they use a fixed rate such as 10% a year set by the manager at launch.
Also in the family: market-capitalisation indices, sectoral indices, style indices — and in ESG, Chapter 5 notes that India shows a skew towards broad-based ESG indices, while the US and Europe have moved towards thematic ones.
A worked example
The funds and returns are illustrative. The index choices follow the workbook's Example 8.7.
Three Category III AIFs report for the year:
| Fund | Strategy | Return | Benchmark used | Benchmark return |
|---|---|---|---|---|
| Kaveri Large Cap | Long-only, large-caps | 15% | NIFTY 50 (broad large-cap) | 12% |
| Tapti Market Neutral | Equal long and short, beta ≈ 0 | 9% | — | — |
| Sabari Absolute | Absolute return | 8% | Fixed 10% hurdle | 10% |
Kaveri on a Rs 200 crore corpus beat its broad-based benchmark by 3 points — Rs 6 crore. The comparison is meaningful because its holdings are the kind of stocks the index holds.
Tapti cannot sensibly be judged against a broad-based index: by design its beta to that index is near zero, so a 20% market rally or fall should barely move it.
Sabari targets an absolute return; the workbook says such funds are not benchmarked against a broad-based market index. Against its 10% fixed rate, it under-performed by 2 points, even though 8% might have beaten a falling market.
The same broad-based index is the right yardstick for one fund and the wrong one for the other two.
Why NISM asks about it
Chapter 8, section 8.5.1 (Broad based indices), defines the term; section 8.2 and Chapter 3, section 3.12.1 (Market Portfolio), use it as the market proxy; sections 8.8 (Performance Benchmarking) and Example 8.7 use it as a benchmark. Chapter 4, section 4.8.2 (Beta Management), and Chapter 10's long-short, market-neutral and directional strategies measure beta against it. Expect a definition question and "which benchmark suits which strategy".
Common exam traps
- Broad based means a whole market segment and a significant share of it — NIFTY 500 is the workbook's example, not NIFTY Bank.
- Broad based indices are proxies for the market portfolio, not the market portfolio itself. The workbook stresses there is no agreed proxy and a wrong one distorts beta and the SML.
- Absolute-return funds are not benchmarked against broad-based indices; they use a fixed rate.
- A market-neutral fund's beta against the broad-based index is zero or close to zero — by construction.
- The 96.1% NIFTY 500 coverage is dated March 29, 2019 in the workbook. Treat it as a snapshot; the current figure will differ.
Check yourself
1.Fund ABC takes long positions mainly in small-cap and mid-cap stocks; Fund XYZ takes long positions in large-cap stocks. Which statement is correct?
- a)Fund XYZ has the higher beta, and should be more aggressive in bull markets
- b)Fund ABC has the higher beta, which is likely to outperform in bull markets and underperform in bear markets, and this risk cannot be diversified away across industries, sectors and geographies
- c)Both have the same beta since both are long-only
- d)Fund ABC's higher beta can be removed by spreading across more sectors
Show the answer
Answer: (b) Fund ABC has the higher beta, which is likely to outperform in bull markets and underperform in bear markets, and this risk cannot be diversified away across industries, sectors and geographies
If Fund ABC takes long positions primarily in small-cap and mid-cap securities, the overall portfolio Beta will be high compared with Fund XYZ which takes long positions in large-cap securities. This is due to the inherent risky nature of the underlying shares. This risk cannot be diversified by investing across industries, sectors and geographies.
High beta investments are likely to outperform the benchmark during bull markets, but are also likely to underperform during bear markets. So ABC's manager should be more aggressive during bull markets compared with Fund XYZ.
Beta measures systematic risk - the change in fund returns for a change in a broad-based index.
A note on the workbook: a later sentence in chapter 4 says high beta in bull markets is favourable "for Fund XYZ which takes long positions". That does not match the example, where ABC is the high-beta fund. Rely on the general rule.
Where this is taught
- Series XIX-C · Chapter 10: Introduction to Indices and Benchmarkingintroduced here
- Series XIX-E · Chapter 8: Indices and Benchmarkingintroduced here
Related terms
- Absolute returnThe plain rupee gain or loss from an investment relative to what was invested — simple to compute, but it ignores both the amount invested and the time taken to earn it.
- BenchmarkThe independently published index a scheme's performance is measured against, chosen to match its investment objective, asset allocation and strategy, and disclosed in the Scheme Information Document.
- IndexA statistical indicator that tracks a portfolio of securities representing a market or part of it, expressed as a change from a base value — so the percentage move matters, not the number itself.
- Market PortfolioThe tangency portfolio M of all risky assets worldwide in market proportions — the one risky portfolio every rational investor holds once a risk-free asset exists; indices serve as its proxy.
- Security Market LineThe graph of CAPM: expected return plotted against beta. In equilibrium every asset lies on it — a security plotting above is undervalued, one plotting below is overvalued.
- Style indexAn index of value stocks (low P/E, low P/B, high dividend yield) or growth stocks (the reverse), built to benchmark style managers — with far higher turnover than broad market indices.
- Composite indexA commodity index spanning several segments — energy, metals, bullion — whose constituents must each weigh 1 to 30 per cent, with at least 80 per cent of the weight in sufficiently liquid futures.
- MSCI India IndexMSCI's index of the large and mid-cap segments of Indian equity — 86 constituents covering about 85% of market capitalisation per the workbook — built for consistent cross-country comparison.
- NIFTY Hybrid Index seriesA family of 6 NSE indices blending NIFTY 50 total return with an aggregate fixed income index in fixed proportions, reset monthly, to benchmark portfolios that hold both equity and debt.
- Dollar denominated indexAn index built to measure returns on Indian equity in US dollar terms — NIFTY50 USD restates the NIFTY 50 by the ratio of the base-date exchange rate to the current one.