FLIN - FLIN: Compelling Setup Ahead Of India's Election Season

2023-11-13 17:15:02 ET

Summary

• Indian equities have resumed their uptrend following a choppy few months.
• Inflation is coming back under control, and the near-term earnings growth path remains strong.
• Ahead of a state/general election boost, low-cost ETFs like FLIN screen attractively.

India has emerged as the best-performing market in Asia yet again this year, helped by its underlying economic growth potential and resiliency to external headwinds. Monsoon-driven inflation pressures, a near-term risk I highlighted in my prior coverage , may have triggered a modest pullback in recent months, but equities have since rebounded in line with a new wave of positive earnings revisions.

Going forward, the setup looks compelling - inflation appears well-contained, and earnings growth remains as strong as ever (+22% in 2023; +14% in 2024), while populist measures have begun rolling in ahead of the elections. Indian large caps aren't stretched either at ~19x headline forward P/E (>20x trailing), a premium to the rest of Asia, but in line with historical levels and their underlying earnings potential. Ahead of a state/general election catalyst in the coming months, I continue to like the Franklin FTSE India ETF ( FLIN ) as an ultra-low-cost play on India.

Fund Overview – Low Cost, Diversified Indian Large-Cap Vehicle

The Franklin FTSE India ETF, which tracks the performance of Indian large-caps via the market-cap weighted FTSE India Capped Index, remains the lowest-priced ETF option listed in the US, with a 0.2% (gross and net) expense ratio. By comparison, comparable large-cap ETFs like the iShares MSCI India ETF ( INDA ), which tracks MSCI India, charge a 44bps premium at 0.64%. The Nifty-50 index tracker, the iShares India 50 ETF ( INDY ), charges an even larger premium at 0.9%. Given Franklin Templeton's track record of maintaining low fees for its international ETFs, I don't expect continued asset growth (note that FLIN's asset base has grown further over the last quarter to ~$457m) to impact the fee structure.

FLIN's other key differentiator remains its more rigid concentration caps, as reflected in its relatively better-diversified sector mix. In line with last quarter, the Financial sector has the largest exposure at a slightly larger 22.1%, followed by Information Technology (12.5%) and Consumer Discretionary (11.7%). Energy (slightly down to 10.5%) and Materials (10.4%) round out the top five, which, on a cumulative basis, amount to ~67% of the overall FLIN portfolio. By comparison, the fortunes of key comparables INDY (~77%) and INDA (~71%) are much more closely tied to a handful of sectors.

Similarly, the fund's single-stock allocation is well spread out, with the slightly larger 212-stock portfolio maintaining only two holdings over the 5% threshold. Conglomerate Reliance Industries Limited ( OTC:RLNIY ) is slightly lower at 7.8%, while HDFC Bank ( HDB ) has emerged as the second-largest allocation at 5.8%, taking over from tech services company Infosys ( INFY ) (down to 4.9%). After tech services leader Tata Consultancy Services ( OTCPK:TTNQY ), another domestic banking group, Axis Bank ( OTC:AXBKY ) (up to 2.4%), has also re-entered the top five, replacing consumer goods company Hindustan Unilever (now down to 2.2%). Overall, the FLIN single-stock composition doesn't deviate too far from INDA and INDY, though its weighting caps and portfolio breadth keep the fund comparably better spread out.

Fund Performance – On Track for Another Strong Year of Returns

After a strong Q2 rebound, FLIN's performance has been choppier in Q3 and early Q4. Still, its YTD return remains very strong at +8.5% in NAV terms (+9.2% in market price terms), outperforming its pricier and less diversified peers INDY (+5.9%) and INDA (+5.9%). In turn, FLIN's compounding rate (in NAV and market price terms) has remained at an impressive +5.8% pace since its inception in 2018. Unlike most other emerging Asia ETFs, the performance has been front-end weighted as well – even after last year's high-single-digit percentage drawdown, the fund's three and five-year annualized figures stand at +12.7% and +10.2%, respectively.

Despite the low fee structure, FLIN's tracking error is wide at over one percentage point (annualized) since inception relative to its benchmark FTSE India Capped Index, though it is narrower than comparable ETF offerings. Income also isn't the fund's strong point (historically sub-1% yield), particularly relative to active alternatives like the India Fund ( IFN ) and Morgan Stanley's India Investment Fund ( IIF ), where payouts are boosted by realized capital gains. Growth-oriented investors indifferent to income should still find a lot to like in FLIN's portfolio of large-caps, though, with the group well on track to deliver low-teens earnings growth next year.

Election Season Kicks Off with More Populism

All signs point to political continuity as the most likely outcome in the upcoming national elections, though the ruling Bharatiya Janata Party (BJP) isn't getting a free pass. Having lost in Karnataka state earlier this year to key opposition party, the Indian National Congress, populism is now emerging as a common theme across both parties. Congress got the ball rolling with a major subsidies platform (fiscal transfers, benefits, etc.) in Karnataka, and the BJP now appears to be following a similar playbook, most recently reversing course on its decision to discontinue a costly free food grain scheme. Instead, the government announced a surprisingly lengthy five-year extension to this program, a likely signal of things to come ahead of the state and general election double-header over the coming months.

From a macro standpoint, the good news is that India has enough fiscal headroom to support an additional 0.5-1% of GDP burden from the 5kg/person food grain scheme. Depending on the outcome of this/next month's state elections, expect more one-off populist measures in the pipeline, particularly in rural areas. Temporary flexibility around the government's fiscal deficit target (5.9% of GDP for fiscal 2024) would probably be a boost for equities, which are already benefiting from a new capex upcycle . In any case, the Indian market tends to outperform during election periods (2004 notwithstanding), so the near-term setup looks as compelling as ever.

Compelling Setup Ahead of India's Election Season

After a shaky start, 2023 is shaping up to be a great year for Indian stocks. As one of the few emerging markets capable of sustaining economic growth in the face of cyclical (rate-driven in the US/EU) and structural (China) slowdowns globally, Indian large-caps rightly trade at a premium valuation. Compared to historical levels, though, the current ~19x multiple on next year's MSCI India earnings isn't stretched by any means. Meanwhile, domestic inflation, despite seeing some transitory spikes due to the weather, has been well-contained relative to the RBI's target range, clearing the path for an easing cycle later next year. Heading into a state/national election cycle in the coming months, which typically portends equity outperformance, the ultra-low-cost FLIN looks well-positioned.

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