Choosing The Best India ETF Is Complex

There are good reasons to choose one Indian ETF over another, but you have to understand those reasons.

India’s been the hottest of the “BRIC” markets in 2014 by a long shot. The benchmark BSE Sensex Index is up more than 37 percent year-to-date, and India ETFs are surging in terms of performance and flows.

Year-to-date, the two leading ETFs in the space, the $2.3 billion WisdomTree India Earnings Fund (EPI | C-73) and the $1.9 billion iShares MSCI India ETF (INDA | C-92), have seen net inflows of $955 million and $1.19 billion, respectively.

Within our ETF.com Alpha Think Tank, India now carries the highest number of strategists with a favorable view on any single international market, including a “thumbs up” from famed macroeconomist Nouriel Roubini and geopolitical strategist Ian Bremmer.

Unfortunately for investors interested in India, choosing the best India ETF is trickier than it may look. That’s because they offer different risks and sector breakdowns, causing divergences in returns.

Source: Bloomberg

Clearly, EPI has outperformed INDA year-to-date by roughly 5 percentage points. You might even look at EPI’s “lower” price-to-earnings multiple (P/E) of 14.32 and deem it a value play in an Indian stock market where valuations are stretched. (Our benchmark, the MSCI India IMI Index, trades at a trailing P/E of 20.26.)

But if you think value means less market risk, thus making EPI a “safer” play, you might want to reconsider.

Risk & Volatility

Sure, EPI outperformed on the upside, but that’s expected due to its higher beta of 1.17 against the MSCI India IMI Index. In comparison, INDA’s valuations might be stretched, but it takes on similar risk against the same benchmark, shown by its 0.98 beta.

Source: ETF.com

When you look at volatility, EPI also exhibits a higher year-to-date standard deviation (daily, annualized), of 18.9 percent, compared with 15 percent for INDA. It’s a short time frame, but again, 2014 brought on the current rally on renewed hopes from Narendra Modi’s election win in May.

Earnings-Weighted Vs. Cap-Weighted

EPI is an interesting case because it’s one of few ETFs where its constituents are selected and weighted by earnings. Even at WisdomTree, most of its funds are dividend-weighted.

EPI’s earnings-weighted portfolio likely contributes to the fund’s overall lower P/E. Because "E” is the denominator of “P/E,”—it makes sense that the weighted-average P/E would tend to be lower if companies with the biggest earnings get the largest weights.

In comparison, INDA is cap-weighted, and currently offers a “growthier” portfolio with a higher P/E that is more in line with the benchmark.

INDA is also far more concentrated in large-caps than EPI, capturing only 66 large- and midcaps, which makes up 85 percent of India’s market cap. EPI holds 230 securities, almost four times as many as INDA, with small- and micro-caps making up almost 15 percent of its weighting.

Costs

India ETFs tend to have poor, or loose, tracking and high expense ratios. Take a look at the tracking results of the ETFs in our India Total Market segment.

Source: ETF.com

In this regard, INDA “shines” on all fronts. Its expense ratio is by far the lowest, at 0.67 percent, or $67 for each $10,000 invested. Its tracking is also the most consistent—INDA tends to trail its index by less than its cost, with less variability than its peers.

In comparison, EPI has a median tracking difference of -1.34 percent over rolling 12-month periods, and over its worst stretch, trailed by as much as 310 basis points!

What It All Means

EPI clearly casts the widest net, but that comprehensive basket comes with a cost both in terms of overall holding costs and market risk.

Just because an ETF has a value tilt, it doesn’t necessarily make it less volatile. In fact, historically, the relationship between beta and valuations is a mixed story, depending on time periods between various market conditions.

So if you have a strong conviction that the Indian market will continue its meteoric rise, then EPI bodes well here. But if you want less market risk and volatility because you’re concerned about a possible sell-off in Indian stocks, then INDA looks to fit that bill better.

At the time this article was written, the author held no positions in the securities mentioned. Contact Dennis Hudachek at [email protected], or follow him on Twitter @Dennis_Hudachek.