2023-09-10 02:59:06 ET
Summary
- India remains one of the few major economies producing steady growth against a slowing external backdrop.
- Near-term weather headwinds will slow growth somewhat but should have little bearing on the long-term earnings growth potential of Indian uber-caps.
- Like the rest of the Indian large-cap ETF universe, the NFTY portfolio doesn’t screen cheaply, though growth-oriented investors will still find a lot to like here.
India’s growth premium to the rest of the world has widened in Q2, with real GDP growth coming in at +7.8% YoY (accelerating from +6.1% YoY previously) against a slowing external backdrop. The investment-led outperformance was reflected in fiscal Q1 2024 earnings, as capital goods and cement companies benefited from strong volumes. Also notable was the resilient consumption despite monetary tightening globally; alongside declining raw material prices, Indian consumer companies look poised to sustain their profitability through the cycles.
There are near-term drawbacks to the Indian equity thesis, though, as a one-two punch of inconsistent monsoon rainfall and an El Nino event later this year look poised to drive higher inflation (albeit temporarily). Coming off a high base, expect consumption to come under pressure as a result, though the offset from manufacturing (PMI accelerating again in August) means India has more than enough to deliver on its high-single-digit % growth target. Thus, investors willing to look past the near-term headwinds should still find a lot to like in the First Trust India NIFTY 50 Equal Weight ETF (NFTY), particularly with the NIFTY 50 uber-caps lagging behind comparable NIFTY small/mid-cap indices this year.
Fund Overview – An Equal-Weighted Portfolio of the 50 Largest Indian Companies
The First Trust India NIFTY 50 Equal Weight ETF tracks the largest Indian-listed stocks by market cap and liquidity (i.e., the uber-caps) via the NIFTY 50 Equal Weight Index. While the index constituents mirror the NIFTY 50 Index, the key difference lies in the equalized weightages (maintained by a quarterly rebalancing process), allowing smaller companies to contribute equally to the index performance. The drawback here is the 0.8% expense ratio, placing the fund at the upper end of comparable Indian large-cap funds listed in the US despite a relatively small ~$101m net asset base.
The periodic rebalancing and reconstitution process keeps the NFTY portfolio concentration in check, as shown by its relatively well-diversified sector breakdown. In line with its US-listed comparables, Financials is the dominant contributor, though at a smaller 19.3%. The lower Information Technology contribution (12.7%) is also notable, with Materials (14.0%) and Consumer Discretionary (13.7%) featuring more heavily instead. The rest of the fund’s exposure comprises the less cyclical Health Care (10.5%) and Consumer Staples (9.4%).
The single-stock allocation shows the extent of NFTY’s diversification, with the 50-stock portfolio (excluding cash) maintaining all of its holdings around the 2% mark. Unlike its large-cap peers, conglomerates like Reliance Industries (RLNIY), HDFC Bank (HDB), and tech services company Infosys ( INFY ) don’t feature as heavily here. Instead, the top holdings are pharma company Cipla Limited ( CPLFY ) and state-owned utility company NTPC Limited (NTPZY), both of which have risen past their 2% weight as a result of their relative outperformance recently.
The main drawback here is the exposure to Adani-linked companies (Adani Enterprises ( ANNRY ) and Adani Ports and Special Economic Zone Limited (ANRTY)), many of which have come under increased scrutiny in recent months. While the combined ~4% allocation shouldn’t influence performance too heavily, investors looking to mitigate their exposure to governance risks might be better off elsewhere.
Fund Performance – Steady Capital Growth but Mind the Tracking Error
Helped by the broader Indian equity rally in recent months, the ETF has now returned +10.9% in NAV terms (+11.8% in market price terms) this year. In aggregate, this means NFTY has compounded its NAV at an impressive +6.5% pace (+6.6% in market price terms) since its inception in 2012. Zooming out, the fund has also delivered strong three and five-year annualized figures of +20.3% and +6.9%, respectively.
Relative to comparable India large-cap funds like the Franklin FTSE India ETF (FLIN), however, performance has been roughly in line despite the higher expense ratio. More worryingly, the tracking error has been persistently wide – over a five-year period, the performance differential vs. the NIFTY 50 Equal Weight Index amounts to over three % points annualized (almost twice as wide as FLIN). On the other hand, maintaining an equal-weight portfolio has proven to be a winner (the NIFTY 50 Equal Weight Index has outperformed the NIFTY 50 Index by over one % point over the last five years), so investors will need to weigh the pros and cons.
Owning NFTY has generally come with a higher distribution yield relative to more growth-oriented Indian funds. The trailing yield, for instance, stands at ~2%, though the slower pace of distributions through March/June 2023 means overall distributions are pacing significantly lower this year. The NFTY portfolio’s lofty 22x earnings valuation also stands out in a ‘higher for longer’ rate environment. That said, the more reasonable 15x cash flow multiple and underlying earnings growth of Indian large caps (+23% in 2023/+15% in 2024) means investors willing to underwrite the growth story should still come out ahead.
Widening Growth Premium Highlights the Resilience of the Indian Story
India’s latest quarterly GDP report saw growth accelerating to +7.8% YoY, yet again exceeding expectations on the back of robust consumption (+6.0% YoY) and investment growth (+8.0% YoY). So even with lower government expenditure (down 0.7% YoY) to keep the fiscal deficit in check, as well as a contraction in exports (albeit narrower at down 7.7% YoY in Q2), the Indian growth engine isn’t slowing down. While an external slowdown will likely keep a lid on export contribution in the near term, expect government spending to become a tailwind ahead of a busy election season (state elections in late 2023 and national elections in early to mid-2024).
The key concerns for now are largely weather-driven. The uneven rainfall distribution over the last month, for instance, has already raised alarm, and an unfavorable monsoon could see continued supply-driven deficits for agriculture. And once we clear the monsoon, there’s an increasingly likely El Nino event later this year (or early next year), which will further affect supplies in the South/Southeast Asian region. The good news is that the government has pre-emptively taken action to build up buffers (the recent rice export ban being a case in point), reinforcing the case that any price spikes in agricultural produce will ultimately prove transitory. And while the RBI has pre-emptively tightened monetary conditions and may even implement a precautionary 25bps hike, the broader disinflationary trend means there isn’t any urgency to deviate from the repo rate path. So even in the likely scenario that growth takes a hit in Q3/Q4, particularly on the consumption side (high inflation weighing on household spending power), I don’t see the long-term India thesis derailing anytime soon.
Ride the Indian Growth Story via the Uber Caps
There isn’t a lot of economic growth in the world right now, but India is bucking the trend. Q2 real GDP growth again outperformed expectations on the back of investment spending and consumption, both of which more than offset the net export decline. This economic growth has also translated into earnings, with fiscal Q1 2024 reporting triggering a new round of earnings revisions, helped by a combination of demand side and cost (mainly raw material) tailwinds.
The risk/reward probably isn’t as attractive from here – while PMI surveys indicate the economy is further accelerating, large-caps have also re-rated alongside the earnings momentum, and supply-driven inflation pressures are on the rise. That said, investors willing to look through the near-term turbulence will still find a lot to like in the more resilient uber-caps tracked by the NFTY fund (the fifty largest India stocks by market cap), particularly ahead of the late 2023/early 2024 election cycle.
For further details see:
NFTY: Ride The Indian Growth Story Via The Uber Caps