Renewed enthusiasm for India’s stock market following the electoral success of Narendra Modi in May looks set to inspire a fresh wave of exchange-traded fund launches in the country.*

The S&P BSE Sensex index has surged 30% this year as of September 22. Overseas allocations to Indian equities have fuelled the rise, prompted by expectations of stronger corporate earnings predicated on future annual GDP growth of 8-9%, up from around 5% this year.

Much of the market outperformance occurred after it became clear that a BJP-controlled National Democratic Alliance would win the election in May. The optimism is driven by the new government’s promises to provide incentives for infrastructure projects, instill budgetary discipline and yet stimulate economic growth.

“The indications are that the government will walk the talk, fast-tracking projects in the transportation, coal mining and power sectors,” observed Anand Radhakrishnan, chief investment officer at Franklin Templeton Investments in India.

“The economy feels vibrant and focused. Staff at state-owned banks are even staying late in their offices to clear back-logs. Maybe there is a shift in work-ethic under way.”

This interest has encouraged ETF providers to believe that index-based products will blossom out of the shadow of racier active funds. “India is again one of the most exciting emerging markets,” noted Sundeep Sikka, president and chief executive of Reliance Capital Asset Management, an ETF provider.

“Investors are seeking opportunities to gain exposure to specific, growing sectors of the Indian economy. ETFs are an easy and cheap way to gain access.”

Mapping the landscape
India’s ETF sector is smaller than those of other Asia-Pacific markets such as Japan, Hong Kong, China and South Korea. But if providers are to be believed, it is set for rapid growth.

Reliance Capital plans to issue as many as 20 ETFs this year alone, moving away from vanilla benchmark products to thematic funds, such as to take advantage of the burgeoning consumer sector.

Bank-focused ETFs have also gained traction due to restrictions on foreign holdings in individual bank stocks, while gold ETFs – already provided by Goldman Sachs Asset Management (GSAM), Reliance Capital and Kotak Mahindra Asset Management – have an evergreen appeal for domestic investors with their traditional fondness for the precious metal.

“ETFs have a great role to play in the future, attracting more funds into the equity market and encouraging greater participation from domestic savers,” said Anubhav Srivastava, head of institutions, product development and fund management at Motilal Oswal Asset Management.

There were 42 ETFs listed on India’s two exchanges as at the end of June with assets of $2.6 billion across 15 providers, according to London-based research firm ETFGI.

GSAM is the biggest ETF provider by assets in India with a 56.7% market share, following its acquisition of ETF specialist Benchmark Mutual Fund in 2011. It is followed by Reliance Capital with 17.9% and Kotak Mahindra with 7.8%. This trio accounts for 82.3% of Indian ETF assets, while the remaining 12 providers each have less than a 5% market share, says ETFGI.

While the market is small, India’s ETF sector was given a steroid injection this April when GSAM launched a $500 million Central Public Sector Enterprise ETF as a vehicle for the Indian government to maximise the price of sales of state-owned assets.

This ETF could drive ETF issuance and greater investor participation. “It has certainly raised the sector’s profile among advisers, fund managers and investors,” said Srivastava.

This sentiment is shared by Sanjiv Shah, head of GSAM India, who points out that brokers are now advising their clients to buy ETFs as a way to ensure wider market exposure, while deploying the balance of their portfolio in more active strategies.

“Tremendous interest has been created [by the CPSE issue] among local brokerages,” Shah said. “They have been actively seeking more information and been willing to pick up the costs to deliver seminars about how the sector operates.”

Still, there are structural issues that need to be resolved if wider participation is to happen. When investors register with a broker, they create dematerialised (demat) accounts in which to hold
shares and securities electronically.

To invest in domestic ETFs you need to have trading and demat accounts, which reduces accessibility for India’s mass of retail investors, noted Puneet Chaddha, India chief executive at HSBC Global Asset Management.

In addition, minimum market-maker quote sizes are required to guarantee liquidity, and there must be maximum discounts to net asset value at exit. Both of which are lacking, because the regulatory regime is as young as the sector itself.

At the same time, it is the potential for high-alpha gains that makes actively managed funds appealing to domestic investors. This could stifle any sustainable development of the ETF sector.

“There so many opportunities among small- and mid-cap stocks for an active fund manager to beat the index that domestic ETFs have little traction,” suggested fund manager Chintan Haria of ICICI Prudential Asset Management, which runs four small ETFs. “The ETF segment is very much at a nascent stage.”

* This feature originally appeared in full in the September issue of AsianInvestor magazine.