The secret behind the top Indian ETF

U.S. investors often stereotype the Indian economy as a cluster of gigantic technology outsourcing companies. But those who bought into the ETFs that most closely conform to that stereotype would have been left lagging not only the real Indian stock market but Wall Street as well.

Image courtesy Satbir Singh: http://www.everystockphoto.com/photographer.php?photographer_id=42780

Mosque in Mumbai

Out of the many funds that concentrate on India, the most technology-heavy are the PowerShares India Portfolio (PIN, quote) and the iPath MSCI India ETN (INP, quote), each weighted roughly 17% in global outsourcing names like Infosys (INFY, quote), Wipro (WIT, quote) and Patni (PTI, quote).

As it happens, PIN is up maybe 2.4% so far this year and INP has gained 6.2%. In both cases, declines in the tech sector have been substantial as a weak rupee does nothing to save these companies from increasingly fierce competition from the Philippines and elsewhere.

INP at least has a massive overweight in india’s high-flying banks ICICI (IBN, quote) and HDFC (HDB, quote) to balance the outsourcers in their weakness. Effectively doubling down on the financial sector — a 25% allocation in INP, as opposed to barely 11% in PIN — made a huge difference.¬†

Likewise, PIN was held back by its energy holdings, none of which trade in the United States and most of which have been under pressure from sagging demand for oil and even worse declines in coal prices. 

The relatively new large-cap Nifty 50 India fund (INDY, quote) has fared a bit better than either INP or PIN, largely due to its combination of an overweight to banks similar to what INP offers and a slight underweight away from technology. The differences may only account for 3% to 4% of the fund’s holdings, but all together they still give INDY an incremental edge: the fund is up 7.3% so far this year.

And the best performer of the pack has been WisdomTree’s India Earnings fund (EPI, quote), up 8%. This portfolio has benefited from all the edges discussed so far, including the lowest allocation to technology at 11%, the highest allocation to banks at 26% and a middle-of-the-road 17% weight in energy.

Of the four, only EPI has beaten the S&P 500 year to date. However, it hasn’t topped the broad Mumbai market itself, where the BSE index is up 8.4%.

Bringing the BSE into the discussion gives us a place to look at just what the role of technology really is in the Indian stock market. Granted, the tech sector accounts for three of the six biggest India stocks that trade in the United States — INFY, WIT and PTI — and about half the total market capitalization in the group.

Add Tata Consultancy, which runs the biggest IT shop in the country and doesn’t trade over here, and technology accounts for maybe $100 billion in market cap.

That’s a huge chunk of the Indian equity that U.S. traders can directly access via American depositary receipts. But this still isn’t the Nasdaq. The banks HDB and IBN are roughly equally as big as INFY, WIT and PTI put together, and counting their non-U.S.-traded counterparts, the sector also clocks in at a little under $100 billion.

Ultimately, India itself is a $1 trillion market. Of the four funds we’ve looked at, only EPI comes close to reflecting that real-world weight — so it shouldn’t come as a surprise that it’s come closest to providing ¬†accurate exposure to the underlying Mumbai market’s actual performance.

A “true” India fund might assign more or less than 10% of its assets to banking and technology and another 15% to energy, although none of those stocks trade in the United States, so you’ll need either a foreign brokerage account or the right “hybrid” mix of ETFs.

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