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How To Invest In India

how to buy etf in india

I did a recent post on India "Too Late To Buy India? " which ran through historic returns and contemplated an outcome of what might lie ahead. I followed it up with another post titled "What Return Can Investors In India ETFs Expect ?", the intent of which was to set out realistic return expectations after considering risks over and above those associated with equity, such as those associated with currency.

And now, I am hopefully closing the series by highlighting why investing in India via Index ETFs such as iShares India 50 (NASDAQ:INDY ), iShares MSCI India (BATS:INDA ), WisdomTree India Earnings (NYSEARCA:EPI ), PowerShares India (NYSEARCA:PIN ), Market Vectors India Small-Cap ETF (NYSEARCA:SCIF ), EGShares India Small Cap (NYSEARCA:SCIN ), iPath MSCI India Index ETN (NYSEARCA:INP ), or iShares MSCI India Small-Cap (BATS:SMIN ) might be not be such a great idea.

Normally, investing via Index ETFs can be a very good idea. It provides great diversification in a market where someone has made the judgment on considering stock quality for stocks included on the index. Free float market capitalization being the basis of most indices allows your capital allocated to equity to be allocated sensibly amongst the several index constituents. So you might invest in SPDR S&P 500 (NYSEARCA:SPY ). If you prefer a value bias, you have a variety of ETFs: you might invest in iShares S&P 500 Value (NYSEARCA:IVE ). If you take exception to the free float market capitalization methodology employed by most indices, you can always consider Guggenheim S&P 500 Equal Weight (NYSEARCA:RSP ).

But when you come around to investing in India, you do not have these choices. Stock selection is important because indices can and do include several companies with poor governance, terrible capital structures and low quality ownership. Allocating your money to shares within a selection is also important: besides avoiding certain stocks, it is fairly common to find that price exceeds value in the better quality names. I have set out below an extract from my recent eBook. explaining what is important to me when investing in India. For those of you who might be inquisitive, Volume 1 of the series "The Hunt for Hidden Value: Making Money in Investable India " will be available free at the Kindle Store on 12/15/2013.

Once a decision to allocate money to equity has been made, there are several additional matters an investor must consider.

Size matters, a person investing in large companies will face lower risks, as well as lower growth expectations. Compare this with a small company, where higher risk and growth expectations are likely. The higher risk associated with smaller companies means that the person investing in smaller companies can expect a higher long term return.

Chasing high priced growth adds risk and will often result in reducing returns. Thus value matters too. Value is viewed in the context of future expectations and time. Expectations of future payouts can be discounted to arrive at a value. The discount rate can be set at a level which prices market and stock specific risk. For an investor, buying a good company at a good value must be an objective as it can be expected to enhance returns in the long term. Buying growth is not a bad idea, but it's important to buy well priced growth. Once market inefficiencies have crept in and driven the value of growth stocks towards exuberance, the time to buy has gone.

Sectors are important too. Financial, IT, Industrial, Consumer Discretionary, Material, Energy, Healthcare, Consumer Staples, Utility and Telecom companies operate in distinct economic areas. There are huge differences in their human capital requirements, their innovation needs and process, the volatility of their earnings from year to year, their capital & capital structure requirements and much more besides. Each sector has vastly different risk levels, and that has a bearing on return potential too. Thus diversification is an area of significant importance. Diversification of size and sectors is best achieved through ownership of several shares distributed across all sectors. It is an important tool to manage unsystematic (Company, Sector or Industry specific) risk.

Governance matters too. While a poor record on governance adds much risk, it does so without increasing return potential. On the contrary, it lowers long term return potential. Your co-owners matter, you have to like them!

Leverage is another monster to watch. Some leverage is good because when the cost of debt is below the return on equity, it creates value for shareholders. Maintaining a small capital base, allows owners to benefit from the spread between return on equity and the cost of debt. Add to this the present value of the tax shield created through leverage and there is a significant advantage. But excessive leverage adds risk and it takes away all of the excess return potential created through the use of moderate levels of leverage.

In India, promoter leverage is another problem to contend with. Promoters of a company on occasion (and several promoters habitually) borrow by pledging shares that they own. During periods of stress, they can and do face margin calls. And if they are over extended, as is often the case, they cannot meet the margin calls. The result can be the sale of a large tranche of shares to satisfy margin requirements and a collapse in the share price as a consequence. This adds much volatility to returns and can be damaging to long term returns. The extent of promoter pledge is an important indicator of co-owner quality.

When you buy iShares India 50, you are buying the CNX NIFTY Index. The NIFTY is made up of fifty stocks of large, well established,

and financially sound companies and is presented by the National Stock Exchange of India, which is the largest exchange in India. It's a nice selection, but I'll leave you with the following thoughts on stock selection:

  1. Remember the sneers of General (Government) Motors (NYSE:GM )? Remember the Tesla (NASDAQ:TSLA ) jokes when they were recipients of loans from the government? And General Motors didn't even have the government as a majority shareholder, while Tesla did not even have the government as an owner. Government ownership is scorned with good cause. Where the government is a majority shareholder, the risk of poor governance and abuse of minority shareholders is high. Poor return of shareholder value and bad capital allocation decisions are common. But the worst abuse comes from decisions which remove the profit motive on account of "public good", which is in truth a political motive in disguise. The NIFTY includes twelve government undertakings.
  2. In addition to government owned companies, there are three companies on the NIFTY which are shunned by the ethical investing crowd and for their poor governance.
  3. And finally the NIFTY includes five companies with troublesome capital structures; by this I mean companies with what I see as unsustainable debt levels.

Thus of the fifty NIFTY stocks, there are potentially twenty in which you would've been reluctant to invest, had you been investing directly in stocks. These twenty stocks make up 21% of NIFTY's free float market capitalization. Is that what you want or expect when you buy iShares India 50?

As far as stock specific capital allocation is concerned, you have no choice when you invest in iShares India 50. Your money will be allocated to stocks in the NIFTY using the free float market capitalization methodology. Does that make you wonder why you are paying a forward multiple of 26 for ITC (Tobacco) when you might prefer Altria (NYSE:MO ) at below 15? If you had a value bias, would you prefer buying Unilever's India subsidiary at a PE of over 30, when you could have the parent Unilever (NYSE:UL ) at about 18? The stocks which command money flow are few, thus while indices can look cheap, the stocks worth owning for the long term in that index are not - the index is cheap because the trash component of the index is very cheap.

When you invest in iShares India 50, you have no control on stock selection or capital allocation. And in an emerging market, stock selection or capital allocation are critical considerations. That brings me to the options a person wanting to invest in India has.

A US person, including a Non Resident Indian (NRI), cannot invest in India based mutual funds because of a combination of adverse tax consequences and US investor protection laws. So a US person can consider US based mutual funds which focus on investing in India if they are not averse to paying the high expense ratios and sales charges. The alternative is to set up a brokerage account and buy stocks directly. It's surprisingly easy for an NRI to open an account with Interactive Brokers and secure access to global capital markets. A US person who is not an NRI can open a brokerage account too, but it is more problematic and it may be a while before a brokerage account will offered by Interactive Brokers.

An NRI who is not a US person, or an Indian resident in India, can look at setting up a brokerage account. They can also consider Indian mutual funds if they are not averse to paying the expense ratios. There are a handful of mutual funds which have managed to outperform markets over the very long term. Amongst others, we have Franklin India Blue-chip Fund, HDFC Top 200 Fund, DSP Blackrock Top 100 Fund, IDFC Premier Plan A, which have delivered solid outperformance to their unit holders over the very long term; but watch the portfolios and take care making your fund selections. Consider using the Dhirendra Kumar's excellent Value Research website to help make your fund selections. And use the Morning Star India website to get a second opinion.

A person who is not a US person or an NRI can consider the brokerage account option, which can be quite problematic until Interactive Brokers starts offering the service (I hear it's coming soon, but have been hearing that for some time now), or consider high cost mutual funds in their country of residence.

If you are interested in investing in India, the best option is to buy shares in specific companies through a brokerage account. If it's too much of a headache, the next best option is to buy India based mutual funds, if permitted by law. If neither of the two preceding methods works for you, seek out a fund managed in your home or other permissible jurisdiction with no sales charge and an expense ratio of below 2.25%, with a good long-term track record. The low cost India ETFs are the final option.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no positions in any of the tickers noted except for UL, to which I made a passing reference in this post. And I have long positions in several Indian listed entities which are included in the portfolios of several Indian ETFs/ETNs.

Category: Forex

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