Kotak says mid-cap indices have low utility due to constant stock changes

Using mid-cap indices as investment tools has low utility because constant changes destroy their historical relevance. Kotak Institutional Equities stated in a 19 September strategy report that mid-cap indices are mechanical and restrictive. The mechanical nature comes from frequent changes to index components, while the restrictive nature stems from a limited number of stocks leading to excessive concentration in specific sectors. Top-down earnings and valuation exercises have little relevance because of frequent index changes, the dominance of a few sectors, and exaggerated stock movements caused by sentiment-driven narratives. Mid-cap indices consist of 150 companies chosen by free-float market capitalisation, and fluctuating stock prices mean included companies change often. Only 46 stocks stayed in the Nifty Midcap 150 index consistently from fiscal year 2022 to the first half of fiscal year 2027. A total of 275 unique stocks entered this index between fiscal year 2022 and fiscal year 2026. This constant churn prevents meaningful historical comparisons like future earnings growth against past earnings growth. Limited stock counts also mean popular sectors heavily influence overall index earnings and valuation, while unpopular sectors remain under-represented. A small number of sectors drive the performance of the Nifty Midcap 150. During six half-year periods of positive returns over the past ten half-year periods spanning 1HFY22 to 2HFY26, the top three sectors contributed between 34 percent and 152 percent of index returns. Furthermore, seven different sectors appeared among the top three sectors by weight across these ten periods.