A few months ago, Barclays introduced a new security dedicated to investing in India. It is called iPathSM SCI India Index ETN (NYSEARCA:INP). Since this is an exchange traded note [ETN], there is very little information on the nature of the security and what it means to invest in it. This post attempts to clarify few of those based on information from Barclays and general research.
What is an exchange traded note?
An exchange traded note, as the name suggests, is a bond like instrument but trades like a regular stock in the stock exchange. All the iPath ETNs are issued with 30 year maturity and 0% coupon/interest rate, meaning that the debt like security will not pay any interest for the 30 years. Unless you are planning to invest more than 50,000 stocks of an ETN your best bet is to buy this just like a stock through your broker. If you are buying more than 50,000 stocks you can deal with Barclays directly.
iPath India ETN
By most accounts INP is a welcome change for a US investor interested in investing in India. Previously the options were limited to two closed end funds Morgan Stanley's India Investment Fun (NYSE:IIF) and Blackstone's India Fund (NYSE:IFN), and Mathews India mutual fund [MINDX]. There are other ETFs and funds such as iShares emerging markets (NASDAQ:ADRE) and Vanguard Emerging Markets (NYSEARCA:VWO) that provide exposure to India as part of larger emerging market exposure.
Unlike other India only funds, the iPath India ETN is based on MSCI India Total Market Index with no active management. In general this translates to lower fees; in fact INP's 0.75% expense is lower than all other India only funds.
But before you hit that buy button on your online broker site, you should know what is good and bad about it.
Differed taxes: One important difference between an ETN and regular ETF is that ETNs do not pay any dividends. All the returns will be paid out at the end of the 30 year period. Of course you can cash out prior to that period by selling the holdings in the open market. If you are bullish on the long term prospects of India and do not want to incur dividend tax during the period you are holding the note, this is the best bet. I am assuming that we are talking about investing out of a taxable account.
Index Tracking: This is the only India fund that tracks an index (MSCI India Total Returns Index) with no active management. Tons of research performed over the long term has shown than index based investing beats active management when adjusted for expenses. The MSCI index reflects the returns after reinvesting all the dividend income. The only concern I have about index is that the telecom and communication sector, which is a huge growth area in India, is underrepresented with only 3 companies and 5% of the total assets. For e.g. all the big name companies with huge cell phone networks including Bharati Telecom and BSNL is missing from the index. This may have to do with index definition "the top marketcap companies trading in National Stock Exchange". So if a company is not listed in the exchange you are out of luck.
Tax treatment: Barclays, the fund manager, believes that investors are not liable for any tax until the security matures (30 years) or whenever you sell your holdings in the open market. But the IRS has not ruled on this one way or the other. If the IRS does not agree with this interpretation, there may be tax consequences. Here is the relevant text from the prospectus:
The United States federal income tax consequences of your investment in the Securities are uncertain. In the opinion of our counsel, Sullivan & Cromwell LLP, your Securities should be treated as described above, but it is possible that the Internal Revenue Service may assert an alternative treatment. Because of this uncertainty, we urge you to consult your own tax advisor as to the tax consequences of your investment in the Securities.
While the dividend reinvestment is good, the prospectus states that the dividend is reinvested after withholding income tax with the assumption that the security holder will be subject to double taxation, both in the US and India. The US and India have a double taxation treaty that allows for tax exemption in the US if the income is already taxed in India. The fund does not seem to take advantage of this treaty.
Indians cannot buy: This is a strange rule; the Securities and Exchange Board of India (SEBI) the securities regulator in India requires that this security not be offered to NRIs (Indians living aboard) or PIO (Person of Indian origin, a status offered by Indian government for people with origins in India). This means that millions of affluent Indians living in the US can not buy this. But Barclays does not seem to enforce this rule. If your status is any of the ones mentioned here, you may want to check with your broker on restrictions.
Barclays credit: Since this is debt instrument, Barclays credit rating may affect the market price of the fund. Investors can expect ample warning in the media before such an event occurs. The value of the security is based on the underlying index and Barclays offers a weekly redemption option that guarantees redemption of the security based on the index value. This should keep the market price close to the net asset value.
In summary, INP offers an attractive way to invest directly in a hot emerging market in a cost effective way. If you are interested in investing for the long term in this market this is the best option out there. Investors should keep a watch for any new developments in the tax treatment that could negatively affect you.