Markets

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

If you bought $100 worth of the BSE 500 Index instead of MSCI India at the beginning of the year, you would have made about $5.50 extra. If you're after exposure to the next China, then why not pocket a bit of extra cash?

Missing Out
MSCI India has underperformed the BSE 500 this year
Source: Bloomberg

The MSCI lags because it still favors India's information services companies and snubs the financial firms that have heavy exposure to India's burgeoning middle class. This doesn't make sense. These IT vendors earn hardly any revenue in India; the bulk of their businesses are in the U.S., followed by Europe.

Five IT vendors -- Tata Consultancy Services Ltd., Infosys Ltd., HCL Technologies Ltd., Wipro Ltd. and Tech Mahindra Ltd. -- comprise 14.3 percent of MSCI India. By comparison, they have only a 7.7 percent weighting in the broader BSE 500 Index.  

When MSCI constructs its indexes, it has foreign investors in mind, weighing individual stocks not just by market capitalization, but also by the amount of shares foreigners can buy in open markets. As a result, the IT vendors, which have more shares available to foreign investors than banks, have a much larger slice of the pie in the MSCI than, say, in the NSE Nifty or S&P BSE indexes. 

This isn't just a philosophical problem. Investors who bought MSCI India are leaving money on the table. 

Donald Trump's tough rhetoric on immigrants and H-1B visas have had a real impact in Mumbai. So far this year, the vendors are down 2.4 percent, compared with financial companies' whopping 30 percent gain. Tech Mahindra is the worst performer this year, down 22 percent, because it has the largest share of headcount in North America. Wipro, on the other hand, managed to eke out a 9.9 percent gain, thanks to its much smaller U.S. exposure.

H-1B Blues
Tech Mahindra's headcount split shows it's most exposed to the U.S. immigration crackdown
Source: CLSA

The companies have other headwinds besides visa issues. The 5.1 percent rally in the rupee against the dollar pressures all exporters, and Goldman Sachs anaylsts estimate that every 1 percent appreciation in the currency dents the vendors' earnings by 2.3 percent to 2.4 percent.

Their product mix is also proving to be a drag. The quick expansion of cloud services is eating into legacy applications businesses, and these firms have been slow to shift into digital products, as Gadfly columnist Andy Mukherjee wrote in May.

India Inc. seems to be coming off four years of financial stress, and investors are tiptoeing into the nation's banks again. ICICI Bank Ltd. is now about 15 percent off its all-time high reached at the start of 2015.

Breaking Out
India Inc.'s ability to service debt has improved
Source: Bloomberg
Footnote: 2017 is fiscal year ending April, 1, 2017

Domestic-oriented housing finance companies are having a spectacular run this year. Blue-chip Housing Development Finance Corp. for instance, has soared 35 percent in dollar terms as the Indian economy recovers from the government's surprise ban on large-denomination rupee notes, announced the same day Trump was elected U.S. President. The market was initially worried that the sudden loss of wealth would keep Indian consumers from buying houses; it was wrong.

Investors in India might start to think it's time for a bit of lobbying. Two years ago, foreign investors persuaded MSCI to include Chinese ADRs -- Chinese stocks listed in the U.S. -- in its benchmark China index. They had complained that a rule requiring companies to list in the same time zone as their domicile of operations excluded ADRs, which were typically fast-growing technology stocks, and that they were left with a lot of state-owned banks in the basket.

Now, a parallel situation is happening in India. While public float is important, global investors in the MSCI seem to be buying a proxy for chronic deflation in developed nations, instead of exposure to the world's fastest growing major emerging market. The index is limiting India's potential. If the MSCI can rethink China, it can rethink India, too.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Shuli Ren in Hong Kong at sren38@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net