Indian stocks have outpaced their global peers in 2024, as a steady economic backdrop has propelled the rally. Equities received another confidence boost after the MSCI rebalanced its major indices in August, keeping India’s country weighting above a fifth of the MSCI Emerging Market Index.
The larger weight represents a watershed moment for Indian stocks, said Paul Turner, executive director at Capex.com Middle East, an online broker speaking to FinanceAsia. He anticipates that the earnings outlook, paired with additional capital from the index’s realignment and existing interest in robust public investment and resilient private consumption, will strengthen market sentiment.
There has been a flood of initial public offerings (IPOs) in recent weeks with Bajaj Housing Finance’s $782 million listing oversubscribed on Monday, September 9, with the offering set to close on September 11. Last month Ola Electric Mobility and Brainbees Solutions both carried out successful large IPOs, with shares climbing strongly, despite both companies not being profitable yet.
However, the realignment places active managers in a difficult bind, as any benchmark adjustment inadvertently impacts a fund’s tracking error. Should Indian equities continue to rally, underweighting an outperforming market could lower returns. Equally, allowing a higher tracking error could pose issues especially with a renewed focus on market volatility following the early August sell-off.
Closing the underweight position comes with notable costs. Considering India’s forward multiple trades at 24 times against the region’s 13 times, utilising a lower priced market to invest into a more expensive one impacts the fund’s performance, an anathema to the “buy low, sell high’’ mantra for stock pickers.
Those valuations are difficult to ignore, Turner noted. “While India’s outlook remains positive, the potential for a correction is higher,” he said, forcing fund managers to generate alpha someplace else.
China conundrum
That decision becomes more pronounced when considering Chinese equities as a funding source. The expected outflow from passive funds is likely to further compress China’s market multiple which currently trades at just 9 times. Even after the rebalance, China remains the largest constituent in the MSCI EM Index.
Besides the valuation gap between Indian and Chinese equities, China’s stock market presents numerous opportunities that embrace the structural shifts in its domestic economy. Coupled with technological advancements, these changes should support the market’s growth profile, according to the PineBridge Mid-Year Asia Equity Outlook note.
Citing that the ratio of earning misses to beats has narrowed, the report adds that “China may offer alpha-generating return potential for long-term investors despite mixed near-term signals and property market woes.” The analysis coincides as more Chinese companies seek opportunities overseas and transform into multinational corporations.
However, despite the stability that is alleviating systemic risks and supporting the banking sector, investors remain sidelined. The MSCI rebalance could potentially spur relative selling pressure until China’s central bank implements new fiscal stimulus and adopts more aggressive interest rate cuts, undermining those alpha-generating opportunities, explains Capex.com’s Turner.
“There is no easy resolution to these challenges,” commented Yi Ping Liao, assistant portfolio manager at Franklin Templeton Emerging Markets Equity, adding that the improvements will take time, during which economic growth will be muted with a scope for tail risks to surface.
India's fundamentals
These factors draw attention towards India, where the investment rationale is supported by structural factors such as demographics, the growing middle class, and supply chain diversification.
Domestic inflows are more evident in India, where financial product developments are attracting household savings into the equity market, said Vivian Lin Thurston, portfolio manager for William Blair’s emerging markets growth strategy, in response to FA. This has provided liquidity for the broad-based market rally, led by small and medium-sized companies which are reporting even faster earnings, supporting the multiple re-ratings.
“Indian equities may appear expensive, but its macro and corporate fundamentals are stronger than those of some other sizeable EM countries such as China, which continues to struggle with a prolonged economic downturn and increased structural challenges.” Thurston added that it would be difficult to justify taking profits from India and rotate into China now.
Amidst uncertainty, volatility management is gaining importance after the VIX index breached 65 in early August, its highest level since the pandemic in 2020. In addition to easier monetary policies and the upcoming US presidential election where bipartisan hostility towards China exists, the premium on India could be warranted as a safe-haven market.
After the announcement, active fund managers may be cornered to follow the index reshuffle more rigidly, competing with domestic investors who are pushing market valuations and forcing them to buy the more expensive India market, no matter the cost.
Back in July, MSCI announced the launch of MSCI Private Capital Indexes, constructed from a broad universe of private asset funds with over $11 trillion in capitalisation.
Encompassing private equity, private credit, private real estate, private infrastructure, and private natural resources, these 130 Indexes complement MSCI’s over 80 real asset fund and property indexes, providing investors with a comprehensive view of global private markets and the full risk spectrum of private real asset investing.
With additional reporting from Andrew Tjaardstra.
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