Tuesday, August 20, 2013

ETF Alert: Should You Invest in This Emerging Market?

From The Motley Fool
After Posco’s pullout from the multi-billion-dollar steel projects in India, the world’s leading steel maker ArcelorMittal (NYSE: MT), has also decided to pull the plug on its Indian investment plan. Posco was gearing up to construct a 6 million ton steel mill while ArcelorMittal was eyeing a project with an annual capacity to produce 12 million tons of steel. Both companies have cited identical reasons: a weak business environment, uncertainty surrounding iron-ore shipments and delays in acquiring land for their respective projects.
India's capital markets are represented in nearly a dozen ETFs, but the largest and most popular one is the WisdomTree India Earnings Fund (NYSEMKT: EPI). The ETF is one of the worst-performing BRIC-nation funds and has dropped by 19.2% this year.
This ETF offers diversity to investors by allocating 22.8% to its biggest segment, financials, followed by 20.6% to energy and 16.7% to the IT sector. Its three biggest firms, Reliance IndustriesInfosys and ONGC, constitute 24.1% of the fund.
The second biggest Indian ETF in terms of assets is the iShares S&P India Nifty 50 Index (NASDAQ: INDY), which focuses on the 50-biggest Indian firms. This ETF is a relatively safer investment due to
its concentration on large-cap stocks. It offers a higher yield than Wisdom Tree India Earnings Fund but it is more expensive as it charges a higher expense ratio and has a larger P/E. It allocated 26.5% of its assets to financials while its three biggest holdings; ITC, Infosys and Reliance Industries, represent 25.7% of the fund.
Exp Ratio
Total Assets
Top Firm
Reliance Industries Ltd (9.54%)
ITC Ltd (10.21%)
Top Sector
Financials (22.76%)
Financials (26.52%)
Blow to Indian foreign investment
Posco and ArcelorMittal represent two of the biggest foreign investment plans in the country and therefore their pullout is a big blow to the government’s efforts, which have been targeting an economic revival by luring overseas capital. Moreover, the country was also aiming to treble its steel capacity from 100 million tons in 2013 to 300 million tons by 2025 but with the cancellation of significant projects, weak investor confidence and the country’s economic woes (discussed later), we can safely assume that India is not going to touch its 2025 target.
Posco and ArcelorMittal's withdrawal highlights the rampant red-tape in the government departments and a lack of a clear environmental policy, which cause significant delays in the implementation of projects.
ArcelorMittal has been struggling due to the weakness in steel demand, particularly from Europe; and I believe that this is also one of the main reasons why the company scrapped its Indian steel-mill plans. The slowdown in the Chinese and European economies is preventing any turnaround of steel prices. This year, in China and Europe, steel prices have tumbled by 14% and 11%, respectively. ArcelorMittal has been one of the hardest hit due to its significant exposure to the debt-ridden continent of Europe. The company is selling assets and shutting down blast furnaces to cut down cost.
On August 1, ArcelorMittal reported its quarterly results in which it swung to a net loss of $780 million from a profit of $1 billion a year ago, and significantly worse than market’s expectations of a profit of $117 million. Its sales dropped by 10% to $20.2 billion while shipments fell 1.8% to 21.7 million metric tons. Once again, Europe has remained its weak spot. Its shares have fallen by 25.8% since January and I believe that it will continue to under-perform this year. The company will be an interesting play when we start seeing signs of improvement from Europe and China, but for now, I would rather stay on the sidelines.
Economic woes
India's economic growth has been slowing down at an alarming rate as the growth levels touched a 10-year low of 5% for the fiscal year ending March 2013. The private consumption has been weak, capital spending has been low and the public expenditure is slowing down; as a result, there are little-to-no chances of a quick economic rebound in the coming quarters. 
Meanwhile, India’s current account deficit touched 4.8% in the last fiscal year, which is considerably above its ideal range of 2.5% of GDP. The lofty oil import bill, coming from high prices, and an increase in the demand for gold coming from the drop in gold prices have given a boost to the country’s imports.
The Indian ETFs will also witness near-term pressure after Goldman Sachs offered advice to sell India's stocks, as reported by Bloomberg. With the Reserve Bank of India stepping in to support the rupee, the country’s economic problems could get worse. The June-through-July outflow from Indian stocks reached $2.8 billion, its highest level since the global financial crisis of 2008. But so far, foreign investors have been keeping faith in Indian stocks, which have witnessed net inflows of $12.8 billion this year. This is significantly better than its other Asian peers. However, with Goldman’s call, we are going to witness an increase in outflows in the coming quarters.

So far this year, the iShares S&P India Nifty 50 Index has remained ahead of the WisdomTree India Earnings Fund, which is shown in the picture above.
Q3 (1 Month)
The WisdomTree India Earnings Fund has recorded net outflows of more than $300 million this year, with each reported quarter showing a negative flow of funds. On the contrary, the iShares S&P India Nifty 50 Index has reported net inflows of more than $120 million this year with positive flows in every quarter. The iShares S&P India Nifty 50 Index has proven to be a much better option, particularly during times of slowing economic growth, due to its smaller basket with a focus towards well established firms.
However, India’s economic woes are expected to continue and at least in the near term, the WisdomTree India Earnings Fund and the iShares S&P India Nifty 50 Index will remain under pressure. A further fall could make them attractive from a valuation standpoint since they would be trading at steep discounts to other emerging market ETFs. Therefore, investors are better off staying away from these ETFs at the moment. 
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Disclosure: I, Sarfaraz A. Khan, have no position in any stocks mentioned and no plans to initiate any within the next 72 hours of this publication. I have no business relationship with any company mentioned in this article.
The Motley Fool owns shares of ArcelorMittal. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.