Be Choosy When Riding Modi Wave
Narendra Modi's apparent victory in India's national election comes as no surprise to sophisticated investors who've been betting on such an outcome. But the ordinary global investor now interested in India might want to ensure there are no surprises.
Even before the votes were counted, India's benchmark CNX Nifty stock index had soared 18% this year in dollar terms and rose more Friday as results came in. Investors not only thought Mr. Modi would come to power, but also that he would repeat his previous performance as the infrastructure-boosting, red-tape-cutting chief minister of Gujarat state.
That stock rally has room to run. Only a small amount of capital has poured into India this year, with foreign institutions bringing a net $6 billion to stocks through mid-May, small compared with the roughly $20 billion during all of crisis-ridden 2013, notes Samir Arora at Helios Capital, a hedge fund. Now that Mr. Modi's coalition looks set to secure a larger parliamentary majority than polls predicted, hopes will swell further.
A big election mandate should buoy expectations among his supporters that Mr. Modi will energize infrastructure spending and manufacturing. Yet investors looking for passive ways to play this face a curious dilemma: they are not entirely buying into a potential Modi boom.
Take some of the biggest India exchange-traded funds listed in New York, such as BlackRock's iShares MSCI India exchange-traded fund, which tracks the MSCI India index. Software and pharmaceuticals make up 28% of the holdings, mostly representing companies who sell outside India and whose reported earnings will weaken as capital inflows leave the rupee stronger against the dollar. The ETF's consumer-sector holdings could fall by the wayside as investors disregard defensive stocks, or comprise firms such as Tata Motors, which gets most of its revenue selling Jaguars and Land Rovers world-wide. The bank, industrial or energy stocks actually sensitive to a domestically driven Modi boom contribute only 55%.
ETFs tracking the Nifty index, such as BlackRock's other India ETF, the iShares India 50, fare better, since the Nifty allocates about 62% toward cyclical stocks. The Wisdom Tree India ETF, which links to its own index, is a further improvement with 70% weighted to cyclicals.
India's top indices may rebalance over time, though until then, investors should watch for what sectors they're betting on. Of course, the more important risk is whether Mr. Modi delivers not just an election sugar high, but also the policies India needs for long-term growth.