Even after the amazing rally in Indian equities this year, the Indian stock market offers very attractive valuations. Combining these low stocks valuations with a cheap currency 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 (PPP) is a relative price level that would allow a customer to buy the same amount of a good domestically as could be bought 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:
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 that invest in Indian securities:
Morgan Stanley India
Market Vectors India Small-Cap
iShares S&P India Nifty 50 Index
WisdomTree India Earnings
EGShares India Infrastructure
EGShares India Consumer
EGShares India Small Cap
iPath MSCI India
*Gross expenses were listed to prepare for dire scenarios. Fee waivers have been announced for INO and SCIN to make their net fees more competitive. **P/E and P/B ratios are forward projections calculated by Morningstar.com.
American investors could invest in India through the Morgan Stanley India CEF (closed-end fund). It trades at a 11.25% discount to NAV (net asset value). This discount stacks with India's cheap currency and the attractive valuations of fund holdings, making this fund even more attractive.
Alternatively, EPI and SCIF are ETFs (exchange-traded funds) whose holdings are attractively valued. They provide an investing opportunities into firms of different market capitalizations at lower valuations than the other funds on this list. The low valuations of these ETF portfolios stack with the current cheapness of the rupee.
Each of these three funds is an attractive candidate for further research and small investment allocations that will diversify a stock portfolio. 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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