INCO - Columbia India Consumer ETF: Good Balance Of Offense And Defense But Too Pricey

2023-05-21 09:39:07 ET

Summary

• Within India, it may be worth considering a little-known ETF - The Columbia India Consumer ETF.
• INCO is well-poised to benefit from the growing clout of the Indian middle class.
• Valuations are inordinately high.

"A consumer is a shopper who is sore about something." - Harold Coffin

In this week’s ‘Leaders-Laggards’ section, I’ve noted how subdued narratives around the China reopening theme have continued to leave a negative mark on emerging markets' outperformance.

Well, if you're prepared to be a little open-minded and spread your tentacles beyond the Red Dragon, then you may consider looking at options in India, which the IMF believes will be the fastest-growing major economy, not just this year (expected real GDP growth of 5.9%), but in FY24 as well, where the prospects are likely to be even better (expected real GDP growth of 6.3%).

In keeping with the growth theme, it’s also worth noting some commentary shared by an Indian expert on Lead-Lag Live who highlighted that it took just 7 years for India to reach two trillion dollars after it had taken a massive 60 years to reach its first trillion dollars of GDP. Going forward, the subsequent trillion dollars are expected to be breached at much faster levels, highlighting the growth potential of this juggernaut. To get a sense of the positive dynamics hovering around India, you may consider listening to the full chat on YouTube.

Within India, it may be worth considering a little-known ETF - The Columbia India Consumer ETF (INCO). Granted, INCO may have only accumulated $77m of AUM over the last 12 years, a fraction of what the iShares MSCI India ETF has procured ($4.7bn). However, what’s particularly commendable is that, since its inception, INCO has absolutely trounced not just the popular INDA ETF, but also the flagship EM ETF - iShares MSCI Emerging Markets ETF (EEM) - by 3x and 12x respectively.

This speaks volumes about the quality of equities that INCO pursues. To elaborate on this product, note that it pursues only Indian consumer companies or businesses involved in sectors such as automobiles and parts, beverages, food production, household goods, leisure goods, personal goods, food and drug retail, general retail, media, travel and leisure, and tobacco. These are all avenues that look very well positioned to receive plenty of attention from middle-class India’s rising propensity to consume.

A recent study by India-based economic research think tank PRICE highlighted the growing stature of the Indian middle class (their share was just 14% in 2005 but currently stands at 31%) whose share could more than double by 2047 and hit levels of 63%. The image below gives you a sense of how pivotal this class is, not just in earnings potential but spending power as well.

In the short-term, Indian consumers should likely also feel more emboldened to spend as inflation has dropped dramatically from 7.8% levels seen in April last year to just 4.7% this year (the lowest reading in 18 months). Even with inflation at relatively high levels in previous months, it’s not as though the Indian consumer has been shying away from spending. In fact, if you consider the trend of consumer confidence readings, you’ll note that the consumer is in good health with the gauge been steadily progressing over the past year.

Lower inflation should also prompt the RBI to keep rates on hold, and not make the cost of financing any dearer than it already is. In fairness, if you had paid attention to a Lead-Lag Live chat last year with fund manager Deepak Shenoy, you would have noted that India was going to be one of those economies that would get a good grip on inflation, particularly on the food side.

Having said that, investors also ought to keep a watchful eye on El Nino weather patterns which could develop during the June-September monsoon season. I say this because, traditionally, during the El Nino years, India has witnessed below-than-expected rainfall, which inevitably leaves an adverse mark on food production and often ends up stoking inflationary conditions.

What’s also interesting about INCO as a product is that it gives you solid exposure to consumer names that could benefit from a cyclical upswing of the economy (~53% of holdings) as well as those that could to benefit from stable demand during difficult economic conditions (~47% of the holdings).

Conclusion

In a Lead-Lag Live discussion with hedge fund economist Skanda Amarnath, I’ve highlighted my concerns over how complacent equity markets have been. Hitherto, the financial markets haven’t paid a great deal of attention to low-rated corporate debt, but this is something that is on the anvil, and when that explodes, the spill over effects from that market could weigh adversely across the globe. When risk-off sentiment gathers pace around global equities, overbought and overvalued products could remain particularly vulnerable to a sell-off.

INCO, it appears, fits the definition of something that is overbought and overvalued. The image below shows you how elevated Indian consumer stocks look relative to a more diversified basket of emerging market equities (across much of its trading history, the relative strength ratio of these two products has typically oscillated between the 0.7-1.1 levels, but currently it is at 1.24x).

Crucially, as per YCharts data, INCO’s constituents currently trade at an exorbitant forward P/E of 42.2x , over 2.4x the corresponding multiple of the flagship iShares MSCI India ETF ( 17.5x forward P/E). No matter how alluring the underlying prospects look, it is difficult to imagine a scenario where one could generate outsized alpha at those elevated P/E levels.

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