Do mutual funds/index fund buy units from the open market (NSE, BSE), or are their transactions off market?
In case of index rebalancing once a year, won’t this create major buying pressure on some stocks if this is happening on the open market in a short timeframe?
Both. They have teams to place orders on markets and for finding liquidity.
And yes index rebalancing can cause good amount of inflows. However, this is partially balanced by index moving out of a lower index (like next 50) and moving into higher index (like nifty 50). Only partially.
Index rebalancing is twice a year for NIFTY and similar indices, not once.
This happened with JioFin. All indices got JIOFIN shares as part of reliance demerger. It was also included in nifty because of demerger.
When it was finally removed, it hit lower circuits for a week since all indices tracking Nifty were selling at market price, in open markets.
You are right. I remember JIOFIN but that was a rather extreme example of a company being kicked out of Nifty 50 and not falling into Nifty Next 50, Nifty Midcap or even Nifty Smallcap indices.
I am particularly interested in buying stocks that were out of Nifty 500 (meaning they were not part of Nifty 50, Next 50, Midcap or even Smallcap indices before). The fact that a company will be receiving index inflows for the first time must help with its price atleast in the EXTREME short term.
You are underestimating the 500th stock’s liquidty and overestimating the AUM tracking that deep into the market.
From portfolio of MO Nifty 500 index fund, the companies at the bottom are
| Company Name | Weightage in N500 | Free float M.Cap (₹ Cr.) |
|---|---|---|
| Anupam Rasayan India Limited | 0.00946629102121724% | 1,771.18 |
| MMTC Limited | 0.00873145803261632% | 1,470.00 |
| Happy Forgings Limited | 0.00808071007800749% | 1,451.35 |
| Indigo Paints Limited | 0.00785287128234969% | 1,534.50 |
A company with 1400-1500 crores free float market cap can easily handle some crores (seems like it could be just a few lakhs too) of new inflows in 1 day. It will not move its price by much.
The only serious case is Nifty. The AUM tracking it is much more than the rest. It can cause serious changes, but the stocks entering it are heavy weights too and can handle such inflows to an extent.
Should you buy stocks that get added to the stock market index - Motilal Oswal?
Podcast on how MFs place orders and how front running happens.
Doesn’t contain much but still, just linking if you want to listen to it.
The inclusion doesn’t always happen on the lower levels. Let’s look at Anant Raj Ltd.
It in not part of Nifty 500 at the moment. It will join the index somewhere between 250-300th position. Freefloat market cap is 8,000 Cr.
When it joins Nifty 500, it also Joins Nifty Smallcap 250. All of a sudden, inclusion in these 2 indices should pump it up a lot given there were 0 passive flows to this before.
Furthermore, the introduction of Nifty 500 Equal Weight index funds would make this even more extreme for the lower level stocks like you mentioned. If the fund gets even 2,000 Cr AUM, that would be 4Cr of buying or about 0.2% of the company’s free float to a single fund. Smallcap 250, Smallcap equal weigh, Midcap Smallcap, Total Market indices etc. would all together pump in a decent chunk into a small cap stock that just got into Nifty 500 for the first time.
I am trying to understand if this will be happening in 1 day? If XYZ Ltd. gets added to Nifty 500 and Nifty Smallcap 250, would the Index funds be obligated to buy the stock within a day, or would they have 1-2 weeks time to buy the stock on open market?
To ensure low tracking error, ETFs & Index Funds would need mimic the index at any given point of time.
So, incase of an Index fun rebalance, how would you go about buying stocks that join the Index (like Nifty 50)?
Assume XYZ Ltd. Joined one of the indexes for your fund on 30th September. Do you just place a market order for this? Do you go about trying to find block deals off the exchange?
Most execute as VWAP on the previous day to ensure you mimic the index.