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Understanding overweight and underweight on stocks..

It is quite common to see fund managers or analysts saying that they are overweight or underweight on a stock. What does overweight and underweight mean in stocks? Why are there overweight vs underweight stocks in India? Are overweight stocks good or bad and how about underweight stocks? At the outset it needs to be remembered that overweight is not a sign of an attractive stock and underweight is not a sign that the stock is unattractive. When I say that I am overweight on the stock, it is always with reference to some benchmark. For example, a fund manager may be overweight or underweight on a stock with reference to the weight of the stock on the Nifty or Sensex. A portfolio manager in a PMS may be overweight or underweight on a stock with reference to the model portfolio approved by the PMS research team. Global investors like FIIs and hedge funds may define overweight and underweight with reference to the weights assigned by the MSCI-India index. (MSCI or Morgan Stanley Capital International is the global benchmark for international indexing and most global fund managers use that as a benchmark).


You can be overweight or underweight with respect to stocks, sectors, themes or even with respect to country allocations. For example, for a long time FIIs had an India allocation that was nearly 200 basis points more than what was stipulated by the MSCI.


Understanding overweight and underweight with respect to stocks..
Let us start off with the base of the MSCI India Index and see how overweight and underweight will work with respect to stock allocations?


                                           Data Source: MSCI


The above table captures the suggested weights assigned by the MSCI for the top-10 stocks in India. The MSCI India index has a total of 79 stocks as part of the index with the top 10 stocks accounting for 45.8% of the overall India index. Let us assume that two international funds; Fund A and Fund B have an exposure of 2.5% and 3.5% of their corpus to Maruti Suzuki respectively. As per the MSCI benchmark the weight for Maruti should be 3.13%. That means Fund A is underweight on Maruti and Fund B is overweight on Maruti. That is what weighting with reference to specific stocks is all about. It needs to be remembered that just because Fund A is underweight on Maruti it does not mean that the fund is negative on Maruti. Similarly, just because Fund B is overweight on Maruti it is not necessary that they are positive on Maruti. Here are the reasons why funds could be overweight or underweight without indicating any stock preference..

Fund A, in the above case, may be already having a substantial exposure to the auto sector in India and hence they may have gone underweight on Maruti to just maintain their overall balance.

In the case of Fund B, the research team may have a view that interest rates in India may be headed downwards and hence they may be overweight on Maruti purely to play on the interest rate sensitive aspect of the stock.

Normally, passive funds like index funds and ETFs tend to tail these allocations. But then the reallocations are done on a periodic basis. During the period, any shifts in portfolio or sharp movement in prices may make the fund overweight or underweight on particular stocks.

Understanding Overweight and Underweight with respect to sectors /industries..
Just as funds can be overweight or underweight on specific stock allocations they can also be overweight or underweight based on sectoral allocation. To understand this point let us focus on the MSCI sectoral allocation in this case..


                                              Data Source: MSCI


The above chart captures the sectoral weights assigned to Indian portfolio by the MSCI. Normally passive funds like ETFs and index funds broadly try to mirror this mix as that is the only way they can reduce their tracking error and reflect the MSCI India Index returns as closely as possible. But for active fund managers this overweight and underweight on sectors boils down to the search for alpha.


Ultimately, it is all about the search for alpha..

The reason fund managers go underweight on sectors is the search for excess returns or alpha. Fund managers are paid to beat the index because if investors want to just earn index returns then they would be better off putting money in index funds, which entail much lower costs. The best way fund managers can generate alpha is by going underweight on underperforming sectors which have obvious structural issues. In last couple of years several sectors have underperformed due to obvious reasons. While pharma and IT have underperformed due to US regulation, telecom has underperformed due to stiff price competition from Reliance Jio. Similarly, PSBs have underperformed due to the mountain of NPAs and the recent PNB fiasco has only worsened their outlook. Under these circumstances the fund manager will typically go underweight on sectors like PSBs, telecom and pharma and will go overweight on private banks, automobiles and FMCG. It is this discrepancy based on a clear view on the outlook for a sector that ultimately generates alpha for fund managers.


More often than not, underweight and overweight is more a search for alpha based on a view on the sector or stock. It is not a statement on the attractiveness or otherwise of the stock or sector in question.

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