Tracking the two key market indices -- the National Stock Exchange's S&P CNX Nifty and the Bombay Stock Exchange Sensex-- may give a vastly different view of what is going on in the markets.

The Nifty has, in fact, started outperforming the Sensex.

Why? Because the Nifty includes the steel major Steel Authority, which has been on a fast escalator in the last few trading sessions.

In fact, the Nifty has spurted 7.2 per cent to 1,281 between August 1 and August 18, while the BSE Sensex has gained 4.3 per cent to end at 3,978.

The big difference in the movement of the two benchmark indices follows inclusion of SAIL in the Nifty on August 4.

But recent changes in both the Sensex and the Nifty suggest that correlation between these indices ought to diminish.

This, in turn, seems to be creating a pressure on funds based on either index. The correlation between the Nifty and the Sensex, which was at 0.9853 two years ago has reduced to 0.9463 now. But correlation is now expected to change drastically.

Steel stocks led by SAIL have seen spectacular gains amidst mind-boggling volumes in a short period.

Indeed, the current month's bull run has been mainly fuelled by SAIL, which has zoomed 117 per cent since the beginning of the current month to Rs 51 per share on Monday.

The counter has been seeing hectic activity, topping traded volumes on the two stock exchanges.

The inclusion of Sail is seen a seen a big move  by a section of fund managers, especially with the steel sector showing signs of recovery.

Meanwhile, index experts point out that SAIL contributes around Rs 21,000 crore (Rs 210 billion) to the overall market capitalisation and the scrip has a weightage of around 4.92 per cent in the Nifty.

Index experts point that every rise or fall of one per cent in SAIL's stock price sees a around six points variation in the Nifty.

It's just inclusion of Steel Authority that is has increased the distortion between the two indices.

On January 17, 2002, two stocks from the Nifty, Kochi Refineries and HCL Infosystems, were replaced with Wipro and Sun Pharma. Wipro now has a 4.91 per cent weightage in the Nifty.

Other market capitalisation-heavy scrips including Gas Authority of India and Nalco are giving different directions on market sentiments.

Other major scrips which contributed substantially to the Nifty rally include Nalco whose market capitalisation increased 23 per cent (Rs 1,627 crore -- Rs 16.27 billion) in the current month to Monday and Tisco recorded a 21 per cent (Rs 1,649 crore -- Rs 16.49 billion) gain.

PSU oil major HPCL's market cap improved 12 per cent (Rs 1,296 crore -- Rs 12.96 billion), while FMCG major Hindustan Lever witnessed a 8 per cent (Rs 2,950 crore -- Rs 29.50 billion) gain during the current month.

Meanwhile, index funds which follow a passive investment strategy, have to re-balance their portfolios following new subscriptions, redemptions, dividend payouts and changes in the composition of the index.

In case this does not happen in time, there is a small difference between the return of the index and the fund.

Such deviations are known as tracking errors and arise out of a number of factors.

Tracking error is an important variable to judge performance of an index fund. It may arise due to a delay in the purchase or sale of shares due to illiquidity in the market, delay in registration of securities, etc.