Can The Surge In India ETFs Continue? (EPI, INP, PIN, INDY, SCIF)

indiaEric Dutram: Over the past year, the Indian stock markets have been posting phenomenally high returns. This can be mainly attributed to the recent investor friendly reforms and proactive steps taken by Government to stabilize the fast deteriorating investment climate in the Indian economy.

The measures taken by the Government to allow direct investments in the retail industry has been severely criticized but finally saw the green light when it received majority support from political parties thereby eliminating any doubt relating to implementation of the proposed plan.

This surely is a welcome step by the government as it is expected to boost funds inflow in the economy, especially considering that similar steps have been taken to boost investments in the economy’s debt plagued air and broadcast industries as well.

Also, for an emerging economy like India, foreign portfolio flows are major movers of the equity markets. Therefore the policy inactions thus far from the Government to tame the mounting debt level have long chased foreign institutional investors away from the Indian capital markets. As a result the Indian equity markets underperformed severely in 2011.

Adding to the volatility of the Indian markets is the twin fiscal and trade deficits which have, for quite some time, blurred the growth outlook for the Indian economy. It also faces significant headwinds from rating agencies like Standard and Poor’s and Moody’s which have warned that if the economy does not keep a check on the mounting debt levels, it could soon lose its investment grade status.

Presently, the economy sports a ‘BBB’ rating from Standard and Poor’s with a negative outlook, which is just one notch above the junk grade level (see France’s Credit Downgrade: How Does it Impact the French ETF?).

However, recent policy measures have paved the way for a remedy. Also, the above par corporate earnings reported in the latest quarter and favorable forward guidance by the management of various companies is a sure indicator of rising business spending and demand restoration in the economy.

These factors have led to the S&P CNX Nifty — a popular benchmark of Indian stocks measuring the performance of the 50 biggest companies in the economy, to go up by about 20% in 2012 (see Time to Buy the India Infrastructure ETF).

For investors expecting this trend to continue, a play could be made on any of the popular Indian ETFs that are currently in the U.S. market. We have highlighted some of our favorites below for those who are looking for a continued surge in the Indian stock market in the near to medium term:

WisdomTree India Earnings ETF (NYSEARCA:EPI) is a Zacks # 2 or ‘Buy’ ranked ETF which tracks the WisdomTree India Earnings Index. It tracks the performance of roughly 196 securities which implies it has exposure in the mid and small cap space as well.

The ETF allocates around 40% of its total assets in the top 10 holdings. EPI charges 83 basis points as expense ratio and has an asset base of $1.21 billion. It has a strong average daily volume of about 3 million shares and it has returned 18% in 2012.

iPath MSCI India Index ETN (NYSEARCA:INP) is a Zacks # 2 or ‘Buy’ ranked ETN. At 89 basis points the expense ratio for the ETF stands pretty high. It has an asset base of $466 million and does volume of 78,000 shares daily. INP has returned around 18% in 2012 (see the Zacks ETF Center).

PowerShares India ETF (NYSEARCA:PIN) is a Zacks # 3 or ‘Hold’ ranked ETF which tracks the Indus India Index. Unlike EPI which spreads out its portfolio across a variety of stocks across different levels of market capitalization, PIN actually tries to replicate Indian equities through a sampling approach of 50 stocks which are predominantly large cap.

It has an asset base of $387 million and an average daily volume of around 738,000 shares. PIN has returned around 22% YTD in 2012.

iShares S&P India Nifty 50 ETF (NASDAQ:INDY) is a Zacks # 2 or ‘Buy’ ranked ETF which tracks the S&P CNX Nifty Index which is a benchmark index for measuring the performance of Indian equities. It tracks the performance of the 50 largest companies from India based on their market capitalization.

Despite the focus on large caps though, the fund is one the pricey end charging investors 92 basis points a year in fees. The ETF has an asset base of $354 million and does a daily volume of 145,000 shares. INDY has returned around 20% during 2012.

Investors seeking a small cap exposure to Indian equities can consider the Market Vectors India Small Cap ETF (NYSEARCA:SCIF). It has a Zacks Rank of 3 or ‘Hold’ and tracks the Market Vectors India Small Cap Index which follows the performance of small cap stocks in India. It has an expense ratio of 0.85% and pays out a yield of 1.45%.

Being a relatively new fund it has been able to amass a modest asset base of around $86 million, however, it has a strong average daily volume of 87,000 shares. Not surprisingly, this small cap ETF has outperformed its large cap peers in this uptrend returning around 20% in 2012.

Investors seeking exposure in the Indian ETFs must note that these ETFs are highly correlated to each other. The following correlation matrix summarizes their strong correlation among each other.

Table1: Correlation Matrix

EPI 100% 96.62% 96.74% 95.94% 91.59%
INP 100% 96.40% 95.41 88.13%
PIN 100% 94.98% 88.10%
INDY 100% 88.00%
SCIF 100%

Thus we see that these ETFs, especially the large cap ones are very strongly correlated among each other with a minimum correlation of around 95%. This is in spite of not tracking same indexes and varying allocations across various sectors.

Nevertheless, Financials, Energy and Technology seem to be the favorite sectors of these Indian ETFs as the three sectors account for a lion’s share of each of these ETFs.

Given their strong correlations it isn’t too surprising that these ETFs have similar risk-return tradeoffs, and as we have seen thus far their performances seem to have a strong resemblance in the positive direction.

Yet, if we go back in time a couple of years we see that this strong correlation of Indian equity ETFs is not always beneficial for investors. The following table explains this phenomenon:

Table 2: Yearly Returns Analysis

2012 18% 18% 22% 20% 20%
2011 -40.24% -40% -36% -36.70% -55.80%
2010 16.19% 17.24% 13.03% 20.57% N.A

While it is true that the Indian ETFs have emerged as clear winners in 2012, the opposite was also true the previous fiscal.

In 2011, these ETFs had a forgettable run as the space was one of the worst performing markets after a great performance in 2010 as well. This can also be attributable to a weak currency — The Indian Rupee had lost significantly within that time frame versus the U.S. Dollar.

Such high volatility might not be a great moral booster for investors and there is no denying the fact that the Indian economy still has a lot of work to do. However, the inevitable question that lurks in everybody’s mind as we inch further into 2013 is “Will history repeat itself and there will be a significant fall in these ETFs as happened in 2011?” Well the odds are certainly against it.

After the dismal runin 2011,Indian equities finally seem to be bottoming out. Also, while the macroeconomic and political headwinds still hint towards the negative side, the economy seems to have got a jumpstart on the policy front with the much needed amendments as of late (see 3 Emerging Market ETFs Protected from Global Events).

Also, India’s huge domestic market coupled with the persistent efforts to create an investor friendly climate is sure to attract foreign funds into the system in the quest for above par growth potential.

India has earned a Zacks outlook of ‘Outperform’ and we are bullish on Indian equities in the near to medium term, suggesting any of the above ETFs could be worth a closer look for investors seeking more international exposure this year.

zacksWritten By Eric Dutram From Zacks Investment Research

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.

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