New Passages to India for ETF Investors

But beware what might be an overheated market.
Author:
Publish date:

Investing in India is about to get easier.

Investors who want exposure to one of the world's fastest-growing economies have so far been limited to a handful of mutual funds. But that could soon change as both

Barclays Global Investors

and

PowerShares Capital Management

are developing exchange-traded products that track Indian stock indices.

The BGI product is called the iPath MSCI India Index ETN and is expected to launch on or around Dec. 20, according to a filing with the

Securities and Exchange Commission

. The product is structured as an exchange-traded note, or ETN, which is a debtlike security that promises to deliver the same returns as a specific index -- in this case the MSCI India Total Return Index, a market-cap-weighted index made up of roughly 70 Indian securities.

PowerShares, meanwhile, has two

India-based exchange-traded funds

in the works. The PowerShares India Tiger Portfolio, which is expected to trade under the ticker PGK, will track the Halter India Tiger Index, which includes both ADRs and U.S.-listed companies that derive the majority of their revenue from India. The index is more concentrated than the iPath product, with about 25 securities represented. This ETF has been approved by the SEC, though PowerShares says it probably won't launch until next year.

PowerShares also has filed with the SEC to launch an ETF that would invest exclusively in securities listed on Indian exchanges, although it's not clear when it could come to market.

Indian stocks have been on a tear -- the Bombay Stock Exchange Sensex is up more than 38% year to date. But investors need to be prepared for some jaw-dropping volatility. For example, during the month of May, the index swung from a high of 12,671 to a low of 9,825, a drop of just over 22%.

"Clearly, India is regarded as one of the most important emerging markets," says J.D. Steinhilber, founder of AgileInvesting.com, an investment-advisory subscription service. He believes the new exchange-traded funds and the exchange-traded note are sure to attract investors because the current India investment options are so limited.

Steinhilber warns, however, that Indian stocks have perhaps the highest valuations among emerging markets. So if investors are looking to get exposure to India, "that should be a point of caution."

Morningstar tracks four investment products that currently offer exposure to Indian stocks: two closed-end funds, the $1.34 billion

Morgan Stanley India Investment Fund

(IIF) - Get Report

and Blackstone Asia Advisors' $1.03 billion

India Fund

(IFN) - Get Report

; and two open-end funds, the $969 million

(ETGIX) - Get Report

Eaton Vance Greater India Fund and the $638 million

(MINDX) - Get Report

Matthews India Fund .

Investors also can gain exposure to India through a variety of diversified emerging-market funds, although these products tend to allocate a relatively small portion of their assets to the market.

All of these products have performed well this year, although they have experienced periods of sharp volatility, in line with the Indian stock market. But investors in the closed-end funds also have had to contend with volatility in the discount or premium of share prices to the funds' net asset values.

Unlike open-end funds, which issue and redeem shares upon request at their net asset value, closed-end funds issue a fixed number of shares. When demand outstrips supply, as it does when the underlying assets are appreciating rapidly, the share price can trade at a premium to net asset value. That means investors will have to pay up even more for exposure to securities that already may be overvalued.

Conversely, when demand for the securities in a closed-end fund wanes, the shares can trade at a discount to their net asset value, meaning investors who sell don't fully realize the value of their holdings.

The Morgan Stanley India Investment Fund's shares traded at a discount to net asset value of 0.5% at the end of November, according to ETFConnect.com. But they were at a premium of 14.37% at the end of January.

Morgan Stanley India Investment Fund (IIF)
Trades at discount to net asset value

Source: ETFConnect.com

The India Fund also has been trading at very large premiums to its net asset value for much of this year, although that also has recently tapered off. As of Nov. 30, the shares were at a premium of 4.7%, down from 28.95% at the end of June, and 31.96% at the end of January.

India Fund (IFN)
Trades at premium to NAV

Source: ETFConnect.com

The products Barclays and PowerShares are unlikely to trade at such big discounts or premiums because, like other ETFs and ETNs, they benefit from complex arbitrage mechanisms.

The ETFs and ETN also will carry lower expense ratios than the closed-end and open-end funds currently available that invest in India. The iPath MSCI India Index ETN expense ratio is 0.75%, and the PowerShares India Tiger Portfolio's is expected to be even lower at 0.60%.

By comparison, as of June 30, IIF carried an expense ratio of 1.37% while IFN charged 1.47%, according to ETFConnect.com. Meanwhile, the Eaton Vance Greater India Fund A share class has an expense ratio of 2.35%. The Matthews India fund expense ratio is 2%, according to Morningstar.