India is catching up with China as the largest country in a gauge of emerging markets, highlighting the dilemma for global investors who are increasing their exposure to India’s vibrant but pricey stock market.
Rising share prices, share sales and rising profits by Indian companies have helped India account for just under a fifth of the MSCI Emerging Markets Index, while China’s share has fallen to a quarter from more than 40% in 2020.
Investors say an MSCI index overhaul scheduled for next month could see India’s weighting surpass 20%, surpassing Taiwan and putting India just behind China.
Narrowing inequality has become a top issue for emerging-market investors this year, as they debate whether to pump money into India’s already-booming market or into Chinese stocks, which are cheaper but have been hit by an economic slowdown.
“The two-consensus trade in emerging markets right now is ‘buy India, sell China,'” said Varun Rajewala, emerging markets portfolio manager at asset manager NinetyOne LLC. “The valuation gap between these two markets is the widest it’s ever been,” he added.
Indian stocks trade at 24 times next year’s expected earnings, compared with just 10 times in China.
The change highlighted the power of indexes in emerging markets by directing billions of dollars in passive fund flows to track the indexes as well as leading active managers to adjust their exposures relative to existing benchmarks.
“Ten or 11 years ago, India was 6-7% of the index. Now it’s closer to 20%,” said Kunjal Galla, head of global emerging markets at Federated Hermes. Indian stocks are already relatively expensive, so the fluctuations in the index “pose an interesting dilemma for us long-term investors or those who value a ‘margin of safety’ valuation.”
“We are slightly underweight India right now, not because we don’t like the country from a top-down macro perspective, but because we are leaning towards a margin of safety and looking to accumulate stocks at much lower prices than their intrinsic value,” Gala said.
Domestic inflows into equity funds have been a significant factor. Between 2016 and 2020, annual net domestic inflows into equity funds averaged $12 billion. From 2021 to 2023, these annual inflows have ballooned to $29 billion, Raijawala said.
While there is skepticism about the sustainability of these flows and valuations, part of the dilemma for investors is that missing out on Indian stocks has meant huge losses in the past.
India is one of the strongest markets in the world in local currency terms and has kept pace with the US market in dollar terms for the past few decades.
It’s also the world’s best market for so-called “multi-baggers” – stocks that have risen ten-fold or more in value, according to Vikas Parshad, portfolio manager at M&G Investments.
“One of the least relevant financial metrics anywhere, and especially in India, is the one-year price-to-earnings ratio,” Parshad said. “That’s why investors have missed out on profits in India for 20 years.”
Consensus earnings per share forecasts for Indian stocks in the MSCI Emerging Markets Index this year and next are in the mid-teens, in line with other emerging markets, according to Bloomberg data.
Profits at Indian companies are growing, but not at a faster pace than in other emerging markets. “India’s profit growth has been pretty normal,” said Sunil Thirumalai, global emerging markets strategist at UBS.
But while Chinese companies have seen their valuations fall in recent years, the opposite has happened for Indian companies, thanks in part to a retail investment boom.
Many Indian households are pouring money into domestic stocks to offset what they see as low interest rates that are at best comparable to the official inflation rate.
Domestic purchases, often through automatic monthly transfers to funds run by big banks such as ICICI, have easily countered foreign institutions’ withdrawal from India.“Foreign holdings have fallen to an 11-year low,” Thirumalai said.
“Overall, global investors remain underweight India,” said Vivian Lynn Thurston, a portfolio manager at William Blair Investment Management Co., noting that valuations are partly to blame. “As India weighting increases, it becomes harder to find attractive value stocks in India, or else valuation metrics will need to be rethought.”
The expansion of mainland China-listed companies continued in 2019, and China’s weighting in the index soared the following year. Still, mainland Chinese stocks are not yet fully incorporated.
“Historically, whenever a country has reached a 25% weighting in the MSCI Emerging Markets index, it has tended to fall from its highs,” said Jitania Kandhari, managing director of Morgan Stanley Investment Management’s emerging markets equities team.
