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By Christopher Gannatti

Anyone who follows emerging markets has been disappointed with the returns they have seen in these equity markets over the past few years. There have been lackluster returns and downward-trending rates of economic growth, which is the opposite of what we've seen in developed markets, especially the U.S. While some will surely consider increasing allocations to developed market equities, we believe that contrarians out there may also be wondering about the potential for attractive entry points into certain emerging markets. Based on my research below, I believe India presents such an interesting opportunity.

Unlocking India's Potential

The story of India as both an economy and an equity market is one that tends to focus on the longer term. The country's massive population, coupled with a favorable demographic picture, definitely points to the potential for a growing consumer class in the future. However, in the recent past, what have investors in India gotten? In a word: volatility. India's markets tend to be more volatile than the broader spectrum of emerging market equities, so they have the potential to capture swings in sentiment that impact emerging markets, which of course can be both positive and negative over time.

A Simple Look at Mean Reversion

In evaluating India's equities, we looked for a framework to utilize the available return history to better understand if there were any simple trends that occurred in years after:

• The MSCI India Index (India's equities) underperformed the MSCI Emerging Markets Index (broader emerging markets) for one year

• India's equities outperformed the broader emerging markets for one year

2013 was a tough year for India's equities, which underperformed the broader emerging markets. The key question: Does history suggest India is likely to bounce back for 2014? Early indicators for the first few months have been pointing in that direction. Of course, no matter what our result, there is never any guarantee that past performance can indicate a future result, but the following analysis shows how India's equities did after one-year periods of both out- and underperformance compared to the broader emerging markets.

India's Equities Performed More Strongly After Underperforming Broader Emerging Markets

(click to enlarge)

Looking at the Performance of India's Equities: In our three categories, India's average performance following underperformance of broader emerging market equities is stronger than following outperformance or just looking at the average of all one-year periods. In particular, India performed 27.7% on average in years following periods of underperformance, which was more than 11 percentage points better than its average return of 16.2% per year.

To give some individual examples of strong periods-one of the best returns came following the 2008 downdraft: the 2009 return was 102.8%. Two other strong years, 2005, with a return of nearly 40%, and 2012, with 26%, also followed years of India's equities underperforming the broader emerging markets. 1996 was the only year where the performance of India's equities was negative, following underperformance of broader emerging markets.

On the other end of the spectrum, in 2007 India's equities outperformed broader emerging markets by 33% but were down about 65% the following year.

In short, it does appear that India's equities have exhibited the potential to snap back after periods of outperformance or underperformance against the broader emerging markets, but of course this can offer no guarantees of what the future may hold.

Looking at India's Performance Compared to Emerging Markets: There has also been increased outperformance of India's equities compared to broader emerging markets following underperforming years. There were seven times where India's equities underperformed broader emerging markets, and it was only during in 1996 where they continued to underperform in the following year, lagging by 8.2%. The higher end of the range was encompassed by 1997 (outperformance by about 23%) and 2009 (outperformance of about 24%).

Appropriate to Consider Entry?

Of course, the answer to this question is different for everyone, but we believe these simple statistics indicate that India should be of interest in 2014. One crucial consideration involves the relationship between equity performance and macroeconomic drivers, which have the potential to influence the currency and have provided headwind for U.S. investors making allocations to India in recent years. In a future blog post on India, we'll take a look at the impact India's currency has had on the equity market performance for U.S. investors and what the outlook is there.

Important Risks Related to this Article

Investments focused in India are increasing the impact of events and developments associated with the region, which can adversely affect performance.

Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty.

Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations.

Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments.

Christopher Gannatti, Research Analyst

Christopher Gannatti began at WisdomTree as a Research Analyst in December 2010, working directly with Jeremy Schwartz, CFA®, Director of Research. He is involved in creating and communicating WisdomTree's thoughts on the markets, as well as analyzing existing strategies and developing new approaches. Christopher came to WisdomTree from Lord Abbett, where he worked for four and a half years as a Regional Consultant.