Indian inflation is once again scaring foreign investors, resulting in lower prices and more attractive valuations for Indian stocks. Though inflation is a serious threat for foreign investors, the fact remains that the Indian rupee is undervalued relative to the U.S. dollar. Combining cheap currency with cheap valuations in individual stocks and discounted closed-end funds can lead to extreme bargains for value investors.
How can we evaluate the risks and rewards of investing in Indian equities and other equity markets?
To examine the investment prospects of different foreign markets, different markets were screened for discounts to Purchasing Power Parity (PPP) of their currencies versus the dollar. India currently has one of the cheapest currencies according to PPP, which is trading near a 60% discount to parity. From a top-down perspective, this is a compelling reason to consider buying rupee-denominated assets with U.S. Dollars.
To assess the risk of investing in nations like India with the cheapest currencies, Investment Freedom and Property Right scores were collected from The Heritage Foundation's 2012 Index of Economic Freedom. Each metric helps weigh risk or value:
The Investment Freedom score assesses restrictions on foreign and domestic investment, legal recourse available to firms and investors, as well as how burdensome regulations are for investors. Higher scores indicate higher freedom, and 100 is the highest score.
The Property Right score assesses how well the government protects private property, how well the government punishes those who unlawfully confiscate private property and corruption in the court system. Higher scores indicate greater property rights, and 100 is the highest score.
Purchasing Power Parity is a relative price level that would allow a customer to buy the same amount of a good domestically as they could by exchanging domestic currency for foreign currency and then buying that good in a foreign country. Simply put, if PPP holds I would be able to buy the same amount of gas in the U.S. as I could in Mexico, either by paying X dollars in the U.S. or exchanging X dollars for Y pesos and then buying the gas in Mexico. Since currencies deviate from PPP, investors could convert dollars into a currency with a discount relative valuation and buy more assets in the foreign market than they could with dollars in the domestic market.
A table of discount currencies and risk scores reveals India is a compelling region for investing:
Sri Lankan Rupee
New Taiwan Dollar
Peruvian Nevo Sol
South African Rand
New Turkish Lira
Honk Kong Dollar
South Korean Won
United States Dollar
Indian equities are an opportunity to invest in a much-heralded BRIC market at discount prices. It is the cheapest BRIC country in terms of currency PPP, and it is a less risky legal environment than Russia or China. By these metrics India is more compelling from a top-down perspective than China or Russia.
There are many attractively priced funds, which invest in Indian securities:
WisdomTree India Earnings
iShares S&P India Nifty 50 Index
EGShares India Small Cap
Market Vectors India Small-Cap
EGShares India Infrastructure
EGShares India Consumer
Morgan Stanley India
*P/E and P/B ratios are forward projections calculated by Morningstar.com.
U.S. investors could invest in India through two discounted close-end funds (CEFs): the India Fund, which trades at a 12.30% discount to net asset value ((NYSE:NAV)), or the Morgan Stanley India CEF, which trades at a 12.19% discount to NAV. These discounts stack with India's cheap currency, making these funds even more attractive. IFN and IIF have paid handsome dividends in the past, but future dividends will be tempered by today's harsh exchange rates. Each of these CEFs charges a reasonable 1.3% in fees. Alternatively, there are many exchange-traded funds (ETFs) whose holdings are attractively valued. SCIN, SCIF, and INXX provide investment opportunities into small caps and infrastructure at lower valuations than the more popular large cap indexes. The low valuations of these ETF portfolios stack with the current cheapness of the rupee.
Each of these five funds is an attractive candidate for further research and small investment allocations. These vehicles are opportunities to gain from a market with better property rights, higher investor freedom, and a cheaper currency than China or Russia.
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