Can India Small Cap ETFs Continue Their Bull Run?

Equity funds have delivered handsome returns in India over the past 3-years courtesy of the uptick in the stock market. Small and mid-caps funds gained the most, averaging 34.2% and 42% CAGR respectively over the past three years, compared with 17.7% by large caps funds. This can primarily be attributed to the fact that the benchmark S&P BSE SmallCap index has jumped 150% in the same time frame compared with the 51% gain by the large-cap S&P BSE Sensex.

The stellar performance by small and mid-caps stocks has attracted investors, leading to higher inflows and a burgeoning asset size for many funds. We believe that this dream run will continue for small caps ETFs in the future based on the following factors:

Government Policy Reforms

Notwithstanding delays in domestic policy reform, the Indian economy is gradually gaining momentum ever since Prime Minister Narendra Modi led NDA government took charge of the office. The government plans to boost infrastructure and open up industries such as railways and defense to foreign investment. Business confidence picked up in the first half of fiscal 2016-17 (April 2016 to March 2017) and households are benefiting from favorable tailwinds due to public sector pay rises and a heavy monsoon.

GST Bill: The Biggest Tax Reform

On August 8, 2016, Indian Parliament adopted a nationwide goods-and-services tax, or GST. The step will blend a variety of state and central levies into a national sales tax, resulting in a solo customs union for India’s 1.3 billion population. The move is expected to create seamless business transaction, lower cost of production of goods and reduce inflation – an economic issue that India has been grappling with for long. As per the government estimate, the implementation of GST will boost GDP by 1 %-2%. (read: What GST Bill Passage Means for India ETFs.)

Strong Growth Projection

The World Bank believes India will continue to grow at a brisk pace of 7.6% in 2016 and 7.7% in 2017 while IMF projects the economy to grow 7.6% for both fiscal 2016–17 and 2017–18. The World Economic Situation and Prospect report, in its mid-2016 update, stated that India is expected to achieve 7.5% GDP growth in 2017 and the economic prospect of the South Asian region will be contingent on the growth trajectory of India and Iran. Notably, India’s economy currently accounts for nearly 70% of South Asia’s GDP.

Easing Interest Rate Policy

In October 2016, a six-member monetary policy committee (MPC) headed by the governor of Reserve Bank of India, (RBI) Urjit Patel decided to cut the repo rate in order to boost the Indian economy in the days ahead. All the members of MPC unanimously voted in favour of the rate cut by 25 basis points to 6.25%, its lowest level since November 2010.

RBI stated: "The accommodative stance of monetary policy and comfortable liquidity conditions should support a revival of credit to the productive sectors.” An improving inflation rate was one of the reasons that drove the rate cut. The committee expects the same to decline further in the near future. Government data shows that on a year-on-year basis, CPI inflation rate declined from 6% in July to 5% in August 2016. The rate was within the targeted range of 2-6%. It is expected to improve further in the upcoming quarters, according to RBI. (read: 4 India ETFs to Buy as RBI Cuts Rate.)

Favorable Macro Economic Data

Several other important macro-economic data also show the bullishness in Indian economy. For instance, foreign direct investment in fiscal 2015-2016 increased 29% year-over-year to around $40 billion. In the second quarter of 2016, India’s consumer confidence index tracked by Nielsen Global stood at 128 (value above 100 suggests that consumers are optimistic). This in turn is indicating high level of consumer spending and strong GDP growth. In addition, the current account deficit came close to balancing in the second quarter of fiscal 2016-17 due to a lower oil bill and subdued gold imports, highlighting India’s reduced vulnerability to external risks.

Bottom Line

Goldman Sachs Group already sees the Indian rupee as one of the top emerging market currencies while Standard Chartered (LON:STAN) Plc projects a rally in this currency courtesy of ultra-easy monetary stances in several developed economies. Investors should note that small and mid-caps ETFs should be favored more by fund managers as these are directly related to the domestic economy. We believe small caps-focused India ETFs will continue to outperform the market in tandem with the growing macro-economic visibility of the country

ETFs in Focus

Below we highlight a few small cap India ETFs which we believe will perform reasonably well in the days ahead:

iShares MSCI India Small-Cap ETF (SMIN): This fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI India Small Cap Index. The fund manages an asset size of nearly $88.3 million and an average daily trading volume of 22,675 shares. The fund charges an expense ratio of 74 basis points (bps) a year. SMIN has gained 13.67% so far this year (as of October 28, 2016).
VanEck Vectors India Small-Cap Index ETF (SCIF): The fund replicates as closely as possible, before fees and expenses, the price and yield performance of MVIS India Small-Cap Index. The fund manages assets worth $216.6 million and an average daily trading volume of 39,466 shares. The fund charges an expense ratio of 89 bps a year. SCIF has rallied 11.76% so far in 2016 (as of October 28, 2016).
EGShares India Small Cap ETF (SCIN): This fund seeks investment results that generally correspond, before fees and expenses, to the price and yield performance of the Indxx India Small Cap Index. It manages an asset size valued more than $21.2 million and an average daily trading volume of 3,388 shares. The fund charges an expense ratio of 85 bps a year. SCIN is up 7.39% so far this year (as of October 28, 2016).
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ISHARS-M IND SC (SMIN): ETF Research Reports

COL-INDIA SC (SCIN): ETF Research Reports

VANECK-INDIA SC (SCIF): ETF Research Reports

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