With its rapidly expanding middle class and increasing global presence on the world stage, India has been one of the most popular destinations for emerging-market investment dollars in recent years. Like China, however, India has an opaque and sometimes unpredictable regulatory apparatus that makes it nearly impossible for individual investors to participate in the securities markets.
To purchase Indian securities, individual investors are required to gain regulatory approval from the Securities Exchange Board of India [SEBI] and obtain a Foreign Institutional Investor license. To discourage speculation, foreign investors incur a 10 percent short-term capital gains tax on securities sold within one year of purchase, and other transaction fees and taxes may apply before investors can return their investment proceeds to their countries of origin. India also limits foreign ownership in certain companies and industry sectors. Once these limits are reached, a prospective purchaser must enter trades in a queue, and an order is filled only when another foreign owner sells shares.
To address some of these obstacles and satisfy investor demand for access to India, Barclays Bank, sponsor of the iShares family of ETFs, launched the iPath MSCI India Index ETN (INP) in December of 2006. This month, we begin regular coverage of this fund in our ETF Report. This exchange-traded note, a debt instrument that trades like a stock on the New York Stock Exchange, tracks 62 Indian companies across the ten GICS industry sectors. Financials (27.44 percent), energy (18.83 percent) and information technology (14.54 percent) were the most heavily weighted sectors as of September 28, the latest date for which complete information is available.
While India has become a haven for business services outsourcing and boasts a handful of globally recognized IT firms—including Infosys (INFY) and Tata Consultancy Services—it is still very much a developing economy. India’s health care and consumer discretionary sectors, for instance, account for relatively small slices—3.42 and 5.14 percent, respectively—of INP’s net assets. Industrials (11.09 percent) and materials (7.09 percent) make up a far larger share of this fund. By contrast, health care stocks represented 11.64 percent of the S&P 500 as of September 30, and consumer discretionary accounted for 9.23 percent of the broad-based U.S. equity benchmark.
Since shares of INP debuted, they have more than doubled in value, and they peaked at a new closing high of $116.30 on January 14. Part of that gain simply reflects the rapid growth of India’s economy, which expanded at an average annual rate of 8 percent over the past three years, one of the fastest growth rates in the world. According to the International Monetary Fund, India’s economy is the world’s fourth-largest according to a measure favored by economists, called purchasing power parity, the nominal exchange rate at which a given basket of goods and services would cost the same across various economies. Only the United States, China and Japan rank higher.
More recently, INP has been trading at a hefty premium relative to its daily indicative value—essentially the value of the underlying index, less fees—leading some commentators to describe the fund as “broken.” The reason for this is complicated and has to do with an attempt by India’s securities regulators to avert a stock market bubble by stemming the rising tide of foreign investment.
In October, the Securities and Exchange Board of India announced its intention to bar foreign investment firms from issuing derivatives based on Indian securities. The rapid run-up in the value of India’s stock market and intense interest by foreign investors prompted the ruling.
In response, Barclays suspended issuance of INP shares from its inventory on Friday, October 26, and shares spiked 14.5 percent during the following Monday’s trading. The SEBI clarified its position one week later, and when Barclays announced on November 5 that it would resume issuing shares of INP from its inventory, the price of the notes fell 13.4 percent in the space of five trading days. Even before this event, the fund’s annualized standard deviation was 23.94, more than twice that of the S&P 500 and seven points higher than that of the MSCI Emerging Markets Index.
To many investors, it may have appeared that the situation in India was temporary and that Barclays would begin issuing new shares of INP in short order. So far, that hasn’t happened. On December 7, Barclays acknowledged that there was no end in sight to the “limitations on issuance, sale and lending” caused by the SEBI’s decision. The result, according to the fund sponsor, was that INP could trade at a premium to its underlying value into the foreseeable future. The latest chapter in this saga opened on January 15, when Barclays announced it would resume lending INP shares from its inventory—presumably for investors who want to sell the fund short—but would maintain its suspension on the issuance and sale of new shares.
While INP has certainly been a good investment for those who purchased it before the regulatory decision that effectively shut down the creation of new shares, its pricing history reveals the risk inherent in investing in emerging markets. In the wake of Barclays’ latest announcement regarding INP, the price has fallen around 29 percent. The problem for investors—even the most diligent do-it-yourself researchers—is that difficult-to-predict regulatory changes and not fundamental factors caused these fluctuations. Although these kinds of risks are in some ways par for the course in the rapidly expanding securities markets of India, China and Vietnam, they can easily catch Western investors off guard.