Market Capitalisation Weighted Index
A market capitalisation weighted index assigns each constituent stock a weight proportional to its market capitalisation (or free-float market capitalisation), so that larger companies have a greater influence on index movement; the Nifty 50, Sensex, and most major Indian indices use a free-float market cap weighting methodology.
In a free-float market cap weighted index, each stock's weight equals its free-float market capitalisation divided by the total free-float market capitalisation of all index constituents. Free-float market capitalisation is calculated by multiplying only the publicly traded shares — excluding promoter holdings, government stakes, and strategic holdings locked in for the long term — by the current market price. This free-float adjustment prevents indices from being distorted by large promoter-held positions that are economically illiquid.
NSE India constructs the Nifty 50 and its sub-indices using free-float market cap methodology. The index committee selects constituents based on criteria including average free-float market cap, trading frequency, and liquidity measures over a rolling six-month window. Weights are rebalanced semi-annually, typically in March and September, to reflect changes in free-float shares and prices. Index rebalancing creates predictable demand for incoming constituents and supply pressure on departing ones, driving significant price and volume activity around effective dates.
The primary advantage of market cap weighted indices is that they reflect the aggregate market judgment on company values — a large company is large because investors collectively valued it highly. They are also self-rebalancing to some extent: as a stock appreciates, its weight increases automatically, reducing the need for frequent adjustments. Transaction costs in replicating a cap-weighted index are low because turnover is minimal between rebalancing events.
The primary criticism is concentration: cap-weighted indices can become dominated by a small number of mega-caps. In the Nifty 50, the top five stocks — typically Reliance Industries, HDFC Bank, Infosys, ICICI Bank, and TCS — historically accounted for 35–45% of the index weight. This means performance of the index was disproportionately driven by a handful of companies, reducing effective diversification. During the 2017–2020 period, the outperformance of a few large financials and technology companies amplified this concentration effect.
Alternative weighting schemes — equal weight, fundamental weight, factor weight — have been developed specifically to address this concentration concern while retaining the objectivity and transparency of rule-based index construction. NSE has launched equal weight and factor index variants of major benchmarks, giving investors who are conscious of cap-weighted concentration an alternative passive vehicle.