2023-10-11 03:19:28 ET
Summary
- The Indian large-cap rally has paused amid inflation and oil price concerns.
- Looking through the transitory headwinds; however, the fundamental story is as compelling as ever.
- Large-cap ETFs like INDY don’t screen cheaply but remain well-justified by their growth potential.
Since I last covered the iShares India 50 ETF ( INDY ), the ETF has seen a slight pullback on the back of above-target domestic inflation (mainly food-related) and heightened uncertainty around crude prices and US bond yields. But fundamentally, the long-term structural Indian growth story has improved. The most notable recent positive was the overwhelming investor vote to include Indian sovereign debt in the JPMorgan Emerging Market Bond index.
Official inclusion will only start from June next year before gradually increasing by 1% each month up to a 10% threshold (targeted by early 2025), though investors typically pre-empt these inflows well in advance. In the mid to long run, expect this decision to catalyze more major index inclusions for Indian sovereign bonds as well, from Bloomberg and FTSE indices to the IMF's 'Special Drawing Rights' (SDR or an IMF-defined basket of reserve assets). At a macro level, this opens up significant long-term funding optionality for India, increasing headroom for future fiscal outlays and adding stability to the current account. Alongside a lower risk-free rate (i.e., the benchmark Indian 10-year debt, which yields among the highest in emerging Asia ) from the passive inflows, Indian equities should benefit massively in the long run.
As always with the Indian market, the catch is the valuation. Per INDY, which tracks the benchmark Nifty 50 index, Indian large caps are currently priced at a premium 23.6x P/E. Yet, this isn't unusual by historical standards, nor relative to its underlying earnings growth (+15% fwd earnings growth using MSCI India as a proxy). Foreign inflows into India, while positive, aren't in bubble territory either (in fact, the streak of consecutive net inflows ended last month ). And domestic flows have mostly buoyed Indian mid/small caps rather than the large caps, paving the way for a potential rotation down the line. All in all, investors willing to stomach some near-term turbulence should still find plenty to like in the structural Indian growth story here; INDY remains a great vehicle to play this theme.
Fund Overview - Largely Status Quo for this Large-Cap Indian ETF
The iShares India 50 ETF tracks, before fees and expenses, the performance of India's benchmark Nifty 50 Index, a basket of the 50 largest Indian-listed stocks by market capitalization. The ETF maintains a 0.9% expense ratio (gross and net), a premium to its closest comparable, the First Trust India NIFTY 50 Equal Weight ETF ( NFTY ) (see coverage here ). The fee structure of both ETFs is well above the lowest-cost single-country Indian ETF option listed in the US, the Franklin FTSE India ETF ( FLIN ) (see coverage here ), which charges ~0.2%. Of note, the exchange ratio remains unaffected by INDY's growing net assets, which now total $667m (up from $644m previously), well ahead of NFTY's ~$111m net asset base.
The largest sector holding remains Financials (down to 35.7%), followed by Information Technology (14.0%), Energy (11.0%) and Consumer Staples (9.3%). As INDY doesn't impose an individual stock weighting cap like NFTY, the sector concentration of its portfolio continues to skew higher. Three other sectors also remain above the 5% threshold - Consumer Discretionary at 7.7%, Materials at 6.7%, and Industrials at 6.1%. The top five sector contribution is slightly down, but at ~77% of the total portfolio, INDY's performance remains highly levered to these areas.
In line with INDY's heavy financials allocation, the single-stock breakdown is dominated by leading Indian banks such as HDFC Bank (HDB), still the largest holding (albeit at a reduced 13.3%), and ICICI Bank ( IBN ) at 7.6%. The non-bank holdings remain unchanged, with Indian multinational conglomerate Reliance Industries Limited ( RLNIY ) leading the way at 9.0%, along with tech services company Infosys ( INFY ) at 6.1% and diversified conglomerate ITC Limited ( ITCTY ) at 4.5%. While the five largest holdings contribute a slightly lower 40.6% of the overall portfolio, the single-stock concentration is still well above comparable Indian large-cap ETFs like FLIN and the equal-weighted NFTY.
Fund Performance - Slight Pullback; In-Line Half-Year Distribution
INDY's YTD return has declined slightly to +7.9% in NAV terms, trailing its equal-weight equivalent, NFTY's +11.9%, and capped large-cap comparable FLIN's +8.8%. Zooming out, however, the fund's uncapped approach has proven to be a winner, compounding at an annualized +9.5% (vs. 6.9% for NFTY) over the last decade and +8.3% over the last five years (vs. 9.1% for NFTY and +6.9% for FLIN). The tracking error is wide (>50bps since inception after fees) relative to the fund's benchmark Nifty 50 Index but not by an unusual margin for a large-cap Indian ETF.
INDY's half-year $0.07/share distribution won't appeal to income investors. While better than last year (no half-year payout), the 30-day yield still stands at an unimpressive ~0.2%. By comparison, NFTY offers a better distribution at ~0.9%, which is probably as good a yield as investors will get in India. While I expect some upside to the yield once INDY pays out its year-end distribution, this is still very much a fund for growth-oriented investors who prioritize high returns on capital over returns of capital.
A Dip-Buying Opportunity
India has been the hottest stock market in Asia this year, with major benchmarks making new all-time highs in September despite a 'higher for longer' rate backdrop globally. Most of the action has been in small/mid-cap stocks, which have far outpaced their large-cap counterparts and now look quite extended relative to historical valuation differentials. By comparison, Indian large-cap ETFs like INDY aren't anywhere near bubble territory when you account for the underlying earnings growth potential (mid-teens % in 2024 for MSCI India).
Also positive is news of a major index inclusion for Indian sovereign debt, a potentially significant passive inflow catalyst. Better flows mean improved funding terms and a lower risk-free rate, benefiting equities long-term. For now, though, near-term uncertainties related to weather-related inflation pressures and higher oil prices have led to a modest pullback. Still, these events have little bearing on the compelling structural growth story. Net, I would accumulate on the dips, particularly ahead of the general elections next year.
For further details see:
INDY: A Dip-Buying Opportunity In Indian Stocks