PIN - PIN: Still A Compelling Option For This Year

2023-05-11 05:10:50 ET

Summary

• There remains a lot to like about the Indian growth story, and the recent upturn in Indian equities post-earnings season could be a sign of things to come.
• Investors looking for a quality portfolio to ride the Indian wave will find the Invesco India ETF, a relative YTD outperformer, a great fit.
• As India’s growth premium continues to filter through to earnings over the coming months, there remains ample upside potential from here.

Indian equities have been unfairly beaten down since I last covered the US-listed Invesco India ETF ( PIN ). However, investors who held through a tough February/ March period will have reaped the April/May gains as sentiment begins to match the strong underlying fundamentals. Recall that the year started with a very positive Union budget for the economy, featuring a significant ramp-up in capex and reduced tax burden without sacrificing fiscal discipline. Ongoing reforms (e.g., a simpler GST regime and Insolvency and Bankruptcy code overhaul) are a timely step in the right direction as well, particularly given India's presidency of the G20 this year, and should boost the appeal of India as an investment destination.

Also positive for valuations is the decelerating inflationary pressures in India, which is clearing the path for an RBI pivot sooner rather than later. While bears will point to the current relative valuation premium to emerging market peers, the pullback in recent months, despite India's earnings growth outlook remaining intact, has moderated the gap. Net, the setup for Indian equities is attractive in 2023, and investing via a low-cost, diversified basket like the PIN fund remains a great option.

Fund Overview - A Play on India's Best-In-Class Franchises

The NYSE-listed Invesco India ETF tracks, before fees and expenses, the performance of the market cap-weighted FTSE India Quality and Yield Select Index, a basket of Indian securities (including American and global depositary receipts) selected based on quality and yield criteria. Unlike other passive Indian funds, PIN has a slight active component in that it also excludes stocks screening in the bottom 10% of its quality and yield scores. The ETF had a $92m market value (up from ~$90m prior) at the time of writing and maintained a ~0.8% expense ratio, making it one of the more competitively priced Indian ETFs available to US investors.

As reflected in the graphic below, the fund's sector allocation remains broadly diversified across sectors, though there has been a notable rebalancing since I last covered the fund. Financials remain the top sector holding at 19.5% (up from 19.3% prior), while information technology has seen a 2.8%pt decline to 14.8% (down from 17.4% prior) amid steep stock price declines for PIN's key IT services holdings post-earnings. Energy has also gained share of the portfolio at 13.0% (up from 12.3% prior), followed by materials at 12.3% (up from 12.1% prior) and consumer discretionary at 10.0% (up from 9.8% prior). With the top-five sectors now accounting for a combined 69.6% of the total portfolio, PIN remains a fairly concentrated fund from a sector perspective.

The fund's single-stock holdings are largely in line with the Q1 portfolio as well. Indian multinational conglomerate Reliance Industries ( RLNIY ) has risen as a % of the overall portfolio to 10.2% (up from 9.5% prior), while IT consulting giant Infosys ( INFY ) has been replaced by development finance leader Housing Development Finance Corporation Ltd as the second largest holding. INFY now makes up 5.8% (vs. 7.5% prior) of the PIN portfolio, with HDFC at 6.2%. Tata Consultancy Services (TTNQY), another Indian IT consulting leader, remains the fourth largest holding at 4.3% (down from 4.8% prior), while Hindustan Unilever rounds up the top five list at 2.9%. The portfolio is also slightly larger at 169 holdings (vs. 165 prior); with the top five holdings accounting for ~29% of the overall portfolio, PIN remains one of the more diversified Indian ETFs in the market.

Fund Performance - Solid Compounding Track Record Intact Despite the Recent Turbulence

The ETF has reversed the declines seen in Q1, with a strong April/May performance driving the YTD return to +0.7% in NAV terms (+0.8% in market price terms). By comparison, the benchmark MSCI India Index and the FTSE India Quality and Yield Select Index have trailed the fund at -2.5% and +0.4%, respectively. PIN has generally shined in the post-COVID years (three-year NAV return at +17.5%), though even over five and ten-year periods, fund performance has been a very solid +6.0% and +6.8%, respectively (in line with the MSCI India Index). Relative to its closest comparable, the iShares MSCI India ETF (INDA), PIN's quality-focused approach to portfolio selection has delivered relative outperformance as well.

While the fund stands out for delivering strong capital returns over the last decade, distributions haven't been as impressive. The $2.99/share distribution for last year implies a low-teens % trailing yield, but most of this has come out from realizing long-term capital gains. The portion of distribution from recurring income runs at <1%, so PIN isn't a great fit for income investors. Until Indian companies mature, reinvesting their excess cash will take precedence over shareholder returns, so I wouldn't expect the low yield to change anytime soon. On the other hand, growth investors who don't mind taking on the risks associated with investing in India will find a lot to like about this fund.

Still a Compelling Option for 2023

Indian equities have been off to a mixed start to 2023, but all signs still point to outperformance this year. On the fiscal policy side, the announced capex spending and reduced tax burden in this year's budget provide ample stimulus for the broader economy; supply-side reforms to attract more foreign direct investment flows bode well for the long term as well. With India also taking over the presidency of the G20 this year, expect more investor-friendly policy-making and reforms down the line.

Valuations should also benefit from monetary policy tailwinds later this year - India's inflationary pressures have likely peaked by now, and a cyclical macro regime shift is on the horizon. Given the increasing probability of an external slowdown driving a lower growth/lower inflation scenario, I suspect an RBI pivot toward rate cuts is on the cards this year as well.

As always, Indian equities trade at a premium relative valuation, though the pullback in recent months has significantly improved the risk/reward. Case in point - the PIN portfolio trades at a historically discounted high-teens fwd P/E despite maintaining exceptionally strong ROEs (>20%) and long-term earnings growth outlooks. Net, going long a cross-section of the Indian market via the low-cost PIN ETF, remains a compelling option, in my view.

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