Among the many indices in the Indian capital market, FINNIFTY is one of the most popular index benchmarks. But what is so different about this particular index? In this article, we will explain what FINNIFTY means, its features, and its methodology.
What is FINNIFTY ?
The Nifty Financial Services Index (FINNIFTY ) tracks the performance of the top 20 financial sector companies listed on the National Stock Exchange (NSE) in India. This index includes leading firms from banks, insurance companies, housing finance companies, and other financial services providers. It monitors the performance of these companies based on their free float capitalization, providing a snapshot of the financial sector's health and trends.
Financial firms are crucial for the growth and stability of Indian companies, especially as economic trends change. Banks provide loans, while Non-Banking Financial Companies (NBFCs) and Housing Finance Companies (HFCs) help create credit and support economic progress. The movement of FINNIFTY depends entirely on the performance of these financial firms. This index serves as a benchmark for traders and analysts to understand market trends, making FINNIFTY an important tool for investment decisions in the financial services sector.
How is FINNIFTY calculated?
Now that we know what FINNIFTY means, let us see how it is calculated. Like any other index, the FINNIFTY computation depends on the approach that considers the market capitalisation of its elements. Simply put, market capitalisation is the market value of a business’s outstanding shares. The FINNIFTY index utilises the free float market capitalisation trading method to accurately reflect market performance. This essentially means that only available shares for trading are factored into the calculation. Meanwhile, the promoters’ holdings and additional types of locked-in stocks are excluded.
The weightage is variable in nature and can alter according to market volatility and periodic updates. To curb a single stock from exerting an unwarranted impact on the index’s movement, each company’s weight in the index is restricted. This weightage is significant as it can reduce the influence a stock’s performance will have on the index. The index is frequently reviewed to ensure the stocks and their weight precisely signify the prevailing state of the financial sector.
Additional read: What is SGX Nifty
How to trade in the FINNIFTY index?
Trading in FINNIFTY is no different from trading in other stock market indices. You can trade using derivative instruments, such as futures and options contracts, which can be found on the National Stock Exchange (NSE).
- Futures: FINNIFTY futures contracts can be bought or sold based on your analysis or speculation of future trends in the financial market.
- Options: With options, you have the choice to purchase the contract, which grants you a right but does not obligate you to buy (call option) or sell (put option) the FINNIFTY at a stipulated price and within a specified time.
Before you invest funds in FINNIFTY , ensure that you have a solid strategy in place. Such instruments are notorious for their volatility, so you should always exercise due diligence before you trade in FINNIFTY .
What is the FINNIFTY index made of?
- Banks: This group represents a significant portion of FINNIFTY , with private and government-based banks. While private banks introduce innovative approaches to assist customers, government banks have a vast nationwide reach.
- Housing Finance Companies (HFCs): These companies provide home loans and serve as an indicator of how well the housing market is performing. The HFCs have a pivotal role in the economy, which is highlighted via FINNIFTY .
- Non-Banking Financial Companies (NBFCs): These institutions offer lending services and other types of banking amenities but do not possess a bank licence. They bridge the divide by catering to consumers and businesses in ways that conventional banks might not be able to.
- Insurance: FINNIFTY also includes a variety of insurance firms offering life, health, car, and home coverage. Such companies help people and institutions manage risks, automatically making them integral to financial markets.
- Other: This section includes companies that handle investments such as mutual funds or help investors buy or sell stocks.
Additional read: What is Nifty FMCG
What are the characteristics of FINNIFTY ?
- Portfolio diversification: FINNIFTY enables you to diversify your portfolio across leading financial firms without having to allocate funds for separate stocks.
- Cost-effective: Trading in FINNIFTY derivatives is comparatively more economical than investing in individual stocks.
- Industry-specific exposure: If your focus is only on investing in the financial sector, trading in FINNIFTY derivatives gives you direct access to this industry’s growth possibilities.
- Liquidity: FINNIFTY derivatives are highly liquid, which means you will find it simpler to enter and exit positions as per your convenience.
- Hedging: You can use the FINNIFTY index to hedge against risks and shield your investment portfolio from any drastic movements in the market.
- Benchmark: FINNIFTY stands as a benchmark for the financial market that helps investors evaluate performance and allocate their assets.
Difference between FINNIFTY and BankNifty
FINNIFTY and BankNifty are prominent indices tracking the performance of financial services companies listed on the National Stock Exchange (NSE), India. While both indices focus on the financial sector, they differ significantly in their sectoral coverage and risk profiles.
1. Sectoral coverage
- BankNifty: Exclusively tracks banking sector stocks, providing a narrow focus on the performance of banks.
- FINNIFTY: Includes a broader spectrum of financial services companies, encompassing banks, insurance companies, non-banking financial companies (NBFCs), and other financial institutions. This wider coverage offers greater diversification and potentially mitigates sector-specific risks.
2. Diversification and risk profile
- BankNifty: Offers limited diversification, as it's solely focused on the banking sector. This concentration can expose investors to sector-specific risks, such as loan defaults, regulatory changes, and economic downturns.
- FINNIFTY: Provides a more diversified risk profile by including various financial services companies. This diversification can help reduce the impact of negative developments within a single sector.
Selection criteria of investing in FINNIFTY
- Sector eligibility: Only companies from the finance sector are eligible for inclusion in FINNIFTY. This ensures that the index accurately reflects the performance of the financial industry.
- Weighting: The weight of each sub-sector within the index is determined by its median free-float market capitalization. This approach ensures that the index's composition reflects the relative importance of each sub-sector.
- Company selection: Twenty companies are selected from each sub-sector, ensuring a balanced representation. Priority is given to companies listed on the NSE's futures and options segment due to their higher liquidity.
- Inclusion criteria: Companies must meet certain criteria, such as having a minimum average free-float market capitalization and not exceeding specific weighting limits, to ensure the index's quality and stability.
Benefits of investing in FINNIFTY
- Diversification: Investing in FINNIFTY allows investors to diversify their portfolios across a range of financial services companies.
- Sector exposure: It provides direct exposure to the growth potential of the financial services sector.
- Trading flexibility: The availability of futures and options contracts on FINNIFTY offers various trading strategies.
- Liquidity: FINNIFTY derivatives are generally highly liquid, facilitating easy trading.
- Hedging: FINNIFTY can be used to hedge against risks in the financial services sector.
- Cost-efficiency: Investing in index derivatives can be more cost-effective than buying individual stocks.
- Benchmarking: FINNIFTY serves as a benchmark for the financial sector, aiding in performance evaluation and asset allocation.
Risks of investing in FINNIFTY
- Concentration risk: Given the relatively small number of constituents, FINNIFTY can be subject to concentration risk, where the performance of a few key companies can significantly impact the overall index.
- Limited exposure to small-cap companies: FINNIFTY primarily includes large-cap companies, limiting exposure to smaller-cap opportunities.
- Sector concentration: The index's heavy weighting towards certain financial sectors can make it susceptible to sector-specific risks.
Closing thoughts
Understanding what FINNIFTY means and comprises can help you streamline your financial goals, especially if you are interested in finance-specific stocks. This index is valuable as it allows you to diversify your portfolio across high-performing companies while also giving you an opportunity to hedge against any risks. But like any other stock or stock index, FINNIFTY comes with its own set of inherent risks, which must be duly assessed. So, if you are trading in FINNIFTY derivatives, ensure you thoroughly research to make the right call. If you are a newbie to this index type, it is highly recommended that you seek the expertise of a financial advisor to gauge your risk appetite and areas of opportunity.
