“It has underperformed by 1.5 per cent annualised over five years and by 1.3 per cent versus the Nifty. The Nifty return over that period was 5.3 per cent, while MSCI India's was only four per cent,” says a report titled ‘What no one told you about passive investing’ by Morgan Stanley Investment Management (MSIM).
MSCI indices are popular among global investors taking passive exposure to this country. MSIM estimates nearly $15 billion has been in Indian equities through MSCI-benchmarked exchange traded funds.
Although MSCI and the domestic indices use free-float market capitalisation to decide the weights of stocks, MSCI also uses a special adjustment called Foreign Inclusion Factor. Essentially, this is the investment headroom available for foreign investors in a particular stock. So, if a stock has little or no room available for further foreign investment, MSCI is compelled to drop it from its India index.
HDFC Bank, despite being the country’s fourth biggest in market capitalisation, isn’t part of MSCI India. For, foreign investors cannot buy the private lender’s stock from the market. Interestingly, though, shares of HDFC Bank are quite liquid on the foreign window—a platform where shares can change hands between two foreign investors. Volumes on the foreign window are 60 per cent of the turnover on the domestic bourses. Another interesting stock cited by MSIM—possibly another reason for MSCI India's underperformance—is Maruti Suzuki. “The stock was excluded from the MSCI index in February 2013, citing lack of foreign headroom. Maruti subsequently increased its foreign ownership limit, post which the stock got re-included in the index in November 2015. Maruti’s stock price was Rs 1,404 on the date of exclusion and Rs 4,556 on the date of re-inclusion. As an investor with money tracking the MSCI Index, one effectively sold at Rs 1,400 and bought it back more than three times higher within three years, a period in which the MSCI Index returned only 30 per cent,” says the note, authored by Amay Hattangadi, managing director at MSIM and Swanand Kelkar, executive director.
The duo also highlight how weightages on the MSCI Emerging Markets
(EM) indices are skewed. India, despite having far higher market capitalisation than South Korea, has lesser presence in the index.
“We find it remarkable that for a lower total market cap than India, Korea’s weight in the MSCI EM Index is over 80 per cent higher. For India to be fully represented in the index in line with the share of EM market cap, India’s weight should be over 10 per cent versus 8.9 per cent (now),” they say.
Adding: “Our simple submission to the owners of those $15 billion is that if you are investing money in a MSCI-linked ETF, beware of the distortions it creates and let the lure of low fees not make you penny-wise and pound-foolish.”