2023-11-24 01:04:55 ET
Summary
- India's GDP growth is expected to slow down in the second half of the fiscal year.
- Loan growth in the banking sector is expected to subside, and the RBI's recent decision to target certain high-yielding loan segments could also play a part.
- NFTY fares rather poorly when compared to the small-cap based SMIN ETF which made its listing debut around the same time as the former.
- Valuations are pricey and the risk-reward on the charts look unappealing.
Introduction
The First Trust India Nifty 50 Equal Weight ETF ( NFTY ) is a $110m sized, 11-year ETF that offers equal weighted coverage to 50 of India’s largest and most liquid stocks that trade on the NSE (National Stock Exchange of India). If you're contemplating a position in this product, here are a few thoughts that may help arrive at a decision.
Resilient Macro Backdrop May Ebb
Firstly, as far as the macros are concerned, India looks poised to witness a lower cadence of GDP growth in the second half of the ongoing fiscal (India follows a March year-ending period). A prominent institution in India- ICRA believes that after GDP growth of around 7.4% in H1 (April-Sep 2023), growth for the FY could likely only come in at 6% . Official forecasts by the RBI may be a tad higher at 6.5%, but whichever forecast you go with, you're essentially staring at a much slower growth run rate of 4.6-5.6% in H2.
There’s also reason to believe that some of the strong economic momentum seen in H1 was no doubt also spurred by the government’s intention to frontload CAPEX plans. Traditionally around two-thirds of the allocated funds gets deployed via CAPEX by Dec, but this year it will likely be a lot higher at 80% . Now with lower CAPEX support in the second half of the year, this should leave an unfavorable mark on the overall growth.
India also recently witnessed a rather erratic monsoon season, that eventually got categorized as "below normal", the first in 4 years. As a result water reservoir levels in key territories appeared to have dipped. This also means that the Indian farm sector and the momentum in rural India could slow down. Depleting farm conditions also spell trouble for food inflation, as India may now have to resort to pricey imports to fill the gap. As things stand, India’s consumer inflation ( 4.87% ) is not causing much consternation as it is not far from the central bank’s target levels of 4%, but do consider that food inflation continues to trend up to 6.61% from previous levels of 6.56%.
Loan Growth Looks Set To Subside
Investors may also want to pay particular attention to dynamics in the banking sector, as financial stocks take up the largest weight in NFTY’s portfolio. Even here, conditions look set to ease. After benefitting from solid credit growth of 16% in the previous fiscal, Indian banks will likely have to contend with a slower pace of 13-13.5% (Source: Crisil). We suspect this could be a lot lower, as recently the RBI has also taken some steps to slow down the pace of lending in some of the most lucrative and high-growth categories such as personal loans and credit card loans. These categories are reportedly growing at 2x the pace of normal credit growth. Basically, the risk weights that will need to be allotted to these loans going forward will step up from previous levels of 100% to 125%. On the flip side, one may also commend the central bank for its forward-thinking stance in protecting asset quality, as some of these loan segments have already started to witness a spike in delinquency rates.
Not As Good As Small-Caps
To better understand NFTY, we thought we would also contextualize it against the iShares MSCI India Small-Cap ETF ( SMIN ) which also made its debut on the bourses during the same period as the former (Feb 2012). Unlike NFTY which is more focused, SMIN covers a much wider pool of stocks (444).
Also given their relatively low market cap, a lot of these stocks are also likely to be in the relative infancy of their broad lifecycles and offer superior growth potential, quite unlike NFTY's holdings which are more matured, and perhaps less exciting from a growth angle. This could, in some part, explain why NFTY has managed to amass a far greater chunk of AUM over time (almost $500m, relative to only $110m of AUM for NFTY).
It also helps that SMIN is marginally cheaper (expense ratio of 0.74% vs 0.8% for NFTY) and offers some minuscule semi-annual distributions quite unlike NFTY which does not pay any dividends at all.
As far as the relative performance, and the risk-adjusted performance goes, there’s only one clear winner. Since its inception, NFTY has largely underperformed SMIN for most parts, and on an aggregate basis, the return differential works out to 1.75x in favor of the latter.
The more stable operating models of large-caps translate to a lower risk profile for NFTY, with its monthly returns showing a lot less variability compared to SMIN’s holdings (roughly a 600bps difference in the annualized number).
Given a lower volatility profile, the degree of excess returns that NFTY needs to generate relative to the risk-free rate, won't be as pronounced as SMIN's but note that the latter still throws up a much better Sharpe ratio that is 2x better than NFTY’s figure.
Then, even when you consider harmful volatility or downside deviation, NFTY hasn't quite been able to flourish, with a Sortino ratio that is only half as good as SMIN’s corresponding figure.
Closing Thoughts- Unappealing Risk-Reward and Unfavorable Valuations
Then if you look at the current risk-reward on the charts, we can’t say we are jumping up in joy, in fact far from it. The image below shows us that NFTY’s price action over the last 3 years has taken place within a certain range, and timing your entries and exits around the boundaries has so far proved to be fairly rewarding. As things stand, the price is now intriguingly perched around the upper boundary of the range, and even if it breaks past the boundary, it is hardly a breath away from reaching the lifetime resistance of $51.4. All in all, we don't think the risk-reward is too compelling for a long position at these levels.
The long case is further dampened by the picture on the relative strength chart which sheds some insight into how the equally weighted large-cap India stocks are positioned relative to the broader emerging markets landscape. Currently, the relative strength ratio looks rather overextended to the upside, trading around 30% off the mid-point of the long-term range.
Finally, also note how expensive these Indian large caps are. According to Morningstar data, NFTY's holdings are currently priced at roughly 18x P/E, a 60% premium over the corresponding multiple of the iShares Emerging Markets ETF.
For further details see:
NFTY: Not Very Compelling