NIFTY Hybrid Index series

A portfolio that holds both shares and bonds cannot be judged against a share index alone. Beat the NIFTY 50 in a bad year for equities and you have proved nothing about your bonds.

So index providers build composite indices. They blend an equity index and a bond index in fixed proportions.

The NIFTY Hybrid Index series is NSE's family of these. There are 6 indices. Each one mixes NIFTY 50 with an aggregate fixed income index in a stated ratio — 70:30, 65:35, 50:50, 15:85, 40:60 and 25:75.

Two details make them usable. The blend is built from the total return versions of the underlying indices, so coupons and dividends count. And the weights are reset to their stated levels every month, because markets move them apart in between.

Pick the index whose ratio matches your mandate, and the comparison is fair.

Where it sits. Chapter 8, section 8.7 (Stock-Bond (Composite) Indices). Composite indices blend equities as well as bonds and are useful in evaluating the performance of a portfolio with exposure to both asset classes. The workbook gives the NIFTY Hybrid Index series as its example: 6 indices that blend NIFTY 50 TR and the aggregate fixed income indices in various proportions to reflect the performance of hybrid portfolios.

Two construction rules:

• The indices are derived from the total return versions of the NIFTY 50 index and the fixed income aggregate indices.
• Weights of the equity and fixed income sub-indices can drift between monthly reset dates because of underlying asset price movement, and are reset to their pre-defined levels on a monthly basis.

The six (Table 8.5):

So four of the six use the NIFTY Composite Debt Index and two use the NIFTY Short Duration Debt Index. The debt leg is not the same across the family, and the short-duration pair carries much less interest rate risk on its bond side.

One table cell to be careful with. In our stored copy of Table 8.5, the debt column for the 25:75 index prints 25% rather than 75%. The index name itself states the ratio as 25:75, and the other five rows sum to 100%, so read the debt allocation from the name. Flagged here rather than silently corrected.

Where the family fits in Chapter 8. The chapter works up to it: NIFTY Fixed Income Aggregate Indices are 13 indices covering government securities, corporate bonds across rating categories, commercial paper, certificates of deposit, T-bills and the overnight rate; a total return bond index replicates the return from holding the index portfolio, counting price movements, accrued interest and cash flows including coupons, redemptions and repurchases. The hybrid series is built on top of those total return versions.

And where it does not fit. Section 8.8 immediately explains why benchmarking an AIF is hard: AIFs invest across asset classes, derivatives and varying leverage, so no single index fits every fund, and the Manager may instead benchmark against a broad-market index matched to the market capitalisation of the securities it mainly holds.

The portfolio and the monthly returns are illustrative; the 6 indices, the allocations, the total return construction and the monthly reset are the workbook's.

Meridian Balanced Alternatives runs a Rs 100 crore book with a mandate of 50% equity, 50% debt. The right yardstick from the family is the NIFTY 50 Hybrid Composite Debt 50:50 Index.

Start of the month. Rs 50 crore equity, Rs 50 crore debt.

During the month. Equity returns 6.00%, debt returns 0.50% — both on a total return basis, so dividends and coupons are inside those numbers.

The drift. Equity is now 53.00 / 103.25 = 51.33% of the book, not 50%. The index has drifted the same way, because its weights drift between reset dates too.

The reset. On the monthly reset date the index returns to 50:50. Half of Rs 103.25 crore is Rs 51.625 crore each, so the equity leg is cut by:

Rs 53.000 crore - Rs 51.625 crore = Rs 1.375 crore

A manager tracking this benchmark sells Rs 1.375 crore of equity and buys debt with it. A manager who does not will show a tracking difference next month that has nothing to do with stock selection — it is pure weight drift.

Pick the wrong index and the error is bigger than the skill. Suppose the same Rs 100 crore book were measured against the 15:85 index instead. In this month that index would have returned:

(15% x 6.00%) + (85% x 0.50%) = 0.90% + 0.425% = 1.325%

The manager's 3.25% would look like 1.925 percentage points of outperformance — Rs 1.93 crore of apparent alpha on Rs 100 crore, produced entirely by comparing a 50:50 portfolio with an 85%-debt benchmark. Choosing the index whose ratio matches the mandate is the whole job.

Chapter 8, section 8.7 (Stock-Bond (Composite) Indices) with Table 8.5, sitting between the bond index sections and the performance benchmarking sections. Chapter 8 spends most of its length on index construction, so the reliable questions are counting and construction questions.

Expect: how many indices are in the series (6), which equity index they use (NIFTY 50, total return version), how often the weights are reset (monthly), why a reset is needed (weights drift with asset price movement), and matching an index name to its allocation pair. A harder question asks which of the six use the Short Duration Debt Index rather than the Composite Debt Index — the answer is the 40:60 and 25:75 pair.

• Total return versions, not price indices. The hybrid series is derived from the total return versions of NIFTY 50 and the fixed income aggregates, so coupons and dividends are inside the index return.
• Monthly reset, not quarterly or annual. Weights drift between reset dates and are reset to their pre-defined levels on a monthly basis.
• The debt leg differs across the family. Four indices use the NIFTY Composite Debt Index; the 40:60 and 25:75 pair use the NIFTY Short Duration Debt Index.
• The first number is equity. A 15:85 index is 15% equity and 85% debt — the most debt-heavy of the Composite Debt set, not the most equity-heavy.
• In our stored copy the 25:75 row prints a debt allocation of 25%. The index name says 25:75. Take the ratio from the name.
• It is an index, not a scheme. These are benchmarks for hybrid portfolios, not products to invest in.
• A hybrid index is not automatically the right AIF benchmark. Section 8.8 says AIF strategies vary so much across asset classes, derivatives and leverage that a broad-market index matched to the market cap of the holdings may be used instead.