2024-07-24 04:00:21
India is catching up with China to become the largest country in a benchmark emerging-markets index, creating a dilemma for a growing number of global investors exposed to the country’s buoyant but expensive stock market.
Surging share prices, increased stock sales and earnings growth for Indian companies have pushed India’s share of the MSCI Emerging Markets Index to just under a fifth, while China’s share has fallen to a quarter from more than 40% in 2020.
Investors say an MSCI index review due next month could lift India’s weighting to more than 20%, surpassing Taiwan and placing it directly behind China.
The narrowing gap has become one of the biggest issues facing emerging market investors this year, as they debate whether to put money into already red-hot Indian markets or into relatively cheap Chinese stocks that have been hit by an economic slowdown.
“The two consensus trades in emerging markets today are ‘long India, short China,’ ” said Varun Laijawalla, emerging markets portfolio manager at asset manager NinetyOne. “The valuation gap between the two markets is as wide as it’s ever been,” he added.
India’s stock market currently trades at 24 times next year’s expected earnings, while China’s is trading at just 10 times.
The shift also highlights the power of indexes in emerging markets, whether by directing billions of dollars of index-tracking passive fund flows or guiding active managers to align their risk exposures with established benchmarks.
“Ten or 11 years ago, India was 6% to 7% of the index. Now it’s close to 20%,” said Kunjal Gala, global head of emerging markets at Federated Hermes. Since Indian stocks were already relatively high, the index’s shift “presents an interesting dilemma for long-term investors like us or those who are more focused on ‘margin of safety’ valuations.”
“Right now, we are slightly underestimating Indian equities, not because we don’t like India as a country from a top-down macro perspective,” but because we are looking at the margin of safety, or trying to buy stocks at a significant discount to their intrinsic value, Galla said.
Inflows into domestic equity funds, which averaged $12 billion in net annual inflows from 2016 to 2020, have been a key factor. Those annual inflows have surged to $29 billion between 2021 and 2023, Mr. Legawala said.
While there are doubts about the sustainability of these flows and valuations, one of the dilemmas for investors is that missing out on Indian stocks has been very costly in the past.
India is one of the best performing markets in the world in local currency terms and has kept pace with the U.S. market in recent decades in dollar terms.
China is also the best market for the world’s so-called “multipliers,” or stocks that have risen at least 10 times, said Vikas Pershad, portfolio manager at M&G Investments.
“The one-year P/E ratio is one of the most irrelevant financial metrics anywhere, especially in India,” Pershad said. “That’s why investors have missed out on returns in India for 20 years.”
According to Bloomberg data, expected earnings per share for Indian stocks in the MSCI Emerging Markets Index are expected to be around 15% this year and next, similar to other emerging markets.
While Indian corporate earnings are climbing, they are not growing faster than in other emerging markets. “India’s profit growth is actually quite modest,” said Sunil Tirumalai, global emerging markets strategist at UBS.
However, while valuations of Chinese companies have fallen over the past few years, those of Indian companies have seen the opposite, driven in part by a retail investment boom.
Many Indian households are plowing money into the domestic stock market to offset so-called low interest rates, which at best are equal to the official inflation rate.
Domestic buying, often through automatic monthly transfers to funds run by big banks such as ICICI, has easily offset the pullback by foreign institutions out of India. “Foreign ownership has fallen to its lowest level in 11 years,” Tirumalai said.
“Global investors continue to underestimate Indian equities in general,” in part because of valuation issues, said Vivian Lin Thurston, portfolio manager at William Blair Investment Management. “As the weighting towards Indian equities continues to increase, it becomes increasingly difficult for them to find attractive value stocks in India, or they need to rethink their valuation metrics.”
After the expansion of mainland listed companies in 2019, China’s weight in the index increased significantly the following year, but even so, mainland stocks were not fully included.
“Historically, whenever a country reaches 25% weight in the MSCI Emerging Markets Index, they tend to pull back from their highs,” said Gitanya Kandari, managing director of the emerging markets equity team at Morgan Stanley Investment Management.
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