Investors nowadays seem to be awed by the market index. They track the index every now and then, as if they have invested in the index, and not in the stocks. It is surprising that many of the index maniacs chanting slogans like "Boom NEPSE" fail to earn even when the market grows. It's because the increase in the index means nothing unless our stocks performs. It is similar to looking at the overall pass percentage in the exams to guess one's passing status.

Recently, the freefall of the NEPSE Index by over 25 per cent to 2260 levels, followed by the V-shaped recovery to 2980 levels, has no solid reasons whatsoever.

There have been no improvements in the economic fundamentals like 4/12 cap, liquidity status and deficit in the balance of payments that affect the market. However, the index has been wandering like a madman. And so have the investors. The paradigm shifts in the behavioural biases of the newbie traders have resulted in an excessively volatile index.

There has been swings in the index of high-momentum sectors like hydro, finance and development banks. This is due to the devious tendency of some big players to mislead the rookies by cornering such stocks with low supply. This tendency, popularly referred as "topi laidine" in native terms, has put a question mark on the reliability of stock prices as well as those sectoral sub-indexes.

Even if those tendencies are reduced, what about the accuracy of the index formulated by NEPSE? Well, they are erroneous and inefficient. So, the traders that follow the index blindly are moving on a double-edged sword.

It's because on one hand, the index means nothing unless our portfolio performs and on the other, these indexes are inefficient and irrational.

An index is a measure of market movement that represents the general sentiment of the market. It is created by selecting a few stocks that share comparable features like total market capitalisation or business size or industry structure.

The NEPSE index considers the market capitalisation of all the companies listed in the Stock Exchange.

The index is calculated by dividing the total market capitalisation by base market capitalisation, which is then multiplied by a hundred. It is the sheer brilliance of NEPSE that both the variables are wrongly calculated.

Firstly, base capitalisation is not fairly adjusted with regards to new listings that increases the capitalisation.

Secondly, the promoter shares are considered at the market price, which is prima facie faulty.

For instance, if we take NABIL, it has 60 per cent promoter shares with the rest being public shares.

The market prices of promoter share and public shares are 681 and 1,117 respectively.

But in calculating the total market capitalisation, NEPSE calculates the promoter share at the market price of publicly traded shares, which is wrong. This has inflated the NEPSE Index. So, the NEPSE index we see today at 2780 levels is misleading.

Out of the total market cap of all the companies, the major chunk, or about 70 per cent, is promoter share, which is rarely traded.

If we take NTC, for instance, the government owns 91.49 per cent and so only 8.51 per cent is tradeable.

But, how can the NEPSE index reflect the market price movements when major portion of the market cap is, in fact, infrequently traded? A few high market cap stocks like NTC, NABIL, NRIC and NLIC and CIT have the potential to impact the overall index compared to all other stocks combined. For Instance, a 10 per cent increase in a single stock of NTC, keeping all other stock prices constant, will increase the whole NEPSE Index by a whopping 15 points. Does this represent the overall market movements fairly? To overcome the above mentioned inefficiency, NEPSE came out with the Float Index that considers only the tradeable portion of all the listed companies.

However, NEPSE didn't bother to justify the rationale behind the indexes this time around, too. The Float Index was formulated in 2065 B.S. when the market was high as the index was relatively much lower than what it ought to be. The float index is currently 190.93, which means that the market has developed only 1.9 times. Had the base year been 2050 B.S., the Float Index today would have been somewhere near 2780 levels, which would have been the correct representation.

In 2063 B.S., the NEPSE came out with the Sensitive Index, seemingly to meet the international benchmark, which takes into consideration only a certain number of stocks based on their market capitalisation.

Altogether 89 companies fulfilling the required criteria were considered for Category A. However, the base year was taken as 2063 B.S, which ought to have been 2050 B.S.

NEPSE also designed a new index combining the characters of both the Float and Sensitive Indexes. The Float-Sensitive index represents the publicly traded shares of Category A companies selected by NEPSE.

This index seems to be more precise in representing the changes in the market capitalisation of the selected companies by NEPSE. The base capitalisation problem has, however, misrepresented all indexes except the NEPSE Index, as a layman would consider these indexes to represent the market growth from inception, which they don't.

The sub-indexes have a different story altogether.

In 2075 B.S., NEPSE committed yet another blunder by breaking down the sub-indexes irrationally.

The insurance sub-index was broken down into Life Insurance and Non-Life Insurance.

Both the new sub-indices were kept the same as the sub-index of the insurance sector before the breakdown. This practically implies that both the life and non-life insurance have the same market capitalisation.

But is that the case? No.

In a nutshell, there has been errors in formulating the Index, and the erred index can't represent the actual market sentiments fairly. It's a wake-up call for NEPSE to revise its Index correctly so as not to lose its credibility. The market is considered to be the reflection of the overall economy, but a faulty index can't do so.

A version of this article appears in the print on February 14, 2022, of The Himalayan Times.