MSCI India Total Return Index and Indian Economy
Reverse Blogging Technique, Yes used Reverse Blogging technique to publish this blog, indeed my longest Post till now at ibibo blogsphare. What is Reverse Blogging Technique?
The conclusions segment placed on top of the analysis section for readers to choose priority-reading segment wise. Segment 4 & 5 are the research portion for researcher, analysts and Economist and these two segments are quite critical section of this blog. That is why I wrote this post in reverse order in terms of blog writing. Therefore, Reverse Blogging technique terminology have used by me.
This post is bereif note of onging research work to formulate a concept paper considering all emerging Stock Market variance and Critical Compositions of leading and important Economic factors to constitue a theory for Global Capital Market Index.
This Article complied into five segments are:
1. Segment 1 – General (A modern theory to review the Indian Economy and Stock Market)
2. Segment 2 – Conclusions of Segment 3 to 5.
3. Segment 3 – MSCI Index (a Global Barometer to measure the Country Stock performance)
4. Segment 4 – E/P and PBV ratios to forecast average Capital market / investment returns
5. Segment 5 - Macro Economic Factors to Evaluate Capital market / investment returns
Segment 1 - General
INDIAN ECONOMY – MODERN ECONOMIC THEORY
Indian Stock Market since liberalizations has undergone tremendous changes and has evolved as a vibrant system of investment flows. A dynamic capital market is an important segment of the financial system of any country as it plays a significant role in mobilizing savings and channeling them for productive purposes. The efficient fund allocation depends on the stock market efficiency in pricing the different securities traded in it. The modern financial theory focuses upon systematic factors as sources of risk and contemplates that the long run return on an individual asset must reflect the changes in such systematic factors. An enquiry into such systematic factors through different methodologies suggested in finance literature would help the policy makers, investors, to design their investment strategies meaningfully.
It is important to remember that India is a secular, long-term growth story. Even if the US slows down, Indian companies such as IT organizations are likely to benefit as global companies look to outsourcing to reduce costs. Additionally, economic activity is strong in India, whether it be infrastructure-related, telecom, port, airport, retail, investment in infrastructure in other parts of the economy, or capital expenditure, there’s been no slowdown. This level of investment on the ground is continuing to create jobs and increase consumption. This is good news for the economy and, as it feeds into corporate earnings, is positive for investors.
REVIEW – MODERN INDIAN ECONOMY
Does the Indian growth story still hold strong? And if so, does recent weakness represent a buying opportunity for investors? Perhaps the most important factor India has on its side is demographics.
Positive Side, India has the ideal demographic, with lots of young people supporting relatively few older ones. India is home to around quarter of the world’s under 25’s, with 60% of India’s population aged less than 30. Much of the booming service sector has been built on this young, well-educated, English-speaking population. The service sector now accounts for around 50% of gross domestic product (GDP) and, despite the irritation of some British consumers, the trend for outsourcing to India shows no signs of slowing. The recent survey report suggests that the middle class of around 13 million will rise to 140 million by 2025. This will be a consuming population, who are buying domestic goods and services and creating more jobs. It’s a virtuous circle. In few consumer goods sectors have seen spectacular levels of growth. The most obvious is in mobile telephony, where subscribers are growing at a rate of around 7.5 million per month. In general, it is domestic companies supplying these services. Apart, Strong growth is being seen in branded goods, consumer electronics and cars, while at the lower end, it is simpler things like toothpaste. Despite these positive trends, penetration of consumer goods is still small, leaving room for expansion. As per Survey, there are only around 16 credit cards, eight cars and four Internet connections per 1,000 of population. The other big driver has been infrastructure growth. Historically, infrastructure has always been the Achilles’ heel of India, now it is being seen as an investment opportunity. The government has earmarked between $400bn and $450bn to spend on infrastructure. The strength of this internal demand also means that the economy is not as reliant on exports - and therefore the world economic climate - as some other major emerging markets. Only a small percentage of GDP - about 13% - is export-driven. This means that India will keep growing even if the world economy falters. All these factors have helped generate India’s robust GDP growth of around 9% per year, marginally below China, but above that of Russia and Brazil. If that could be maintained, India would be on course to become the world’s second largest economy after China within 30 years.
INDIAN STOCK MARKET REVIEW
The stock market has also broadened out. Indeed, 15 years ago there were only 40 companies, which were large and liquid enough for investment. Now the relevant universe is 900 stocks, with plenty of new sectors such as media, infrastructure and property. This has been expanded by government privatizations and other flotation. Not all of these have gone to plan, however, and shares in Reliance Power dropped sharply after its $3bn flotation. But it is difficult to ignore the fact that the Indian market now trades at a substantial premium to other emerging markets.
Emerging markets have provided a safe haven, despite their ‘risky’ perception. The levels of risk within Asian companies are not as high as some of those in developed markets. There are some excellent global funds available, which provide an allocation to India, but also other regions around the world and are actively monitored and managed to change the percentages held to suit market conditions. The growth story in India is sound. Well-run companies continue to deliver good earnings, fuelled by massive infrastructure development and a growing consumer economy. These factors are unlikely to reverse. India is also lightly exposed to the fortunes of the global economy and could therefore outperform if the US turns down. However, valuations are relatively high even after the recent falls in price and other emerging markets may offer better short-term value.
Year 2008, the economic news has remained buoyant, supporting claims that India’s domestic strength insulates it against world economic turmoil. But investors’ waning appetite for risk has sliced 14% off the Indian stock market since January 1 2008. Last year, burgeoning consumer spending and much-needed infrastructure growth helped the Morgan Stanley Countries’ Index (MSCI) India deliver a 71% return, the highest of any major Asian market.
Late in the month of Year 2007 and beginning of 2008, the market declined sharply as investors became concerned about deteriorating conditions in the US housing market and the impact this could have on the US and global economies. However, it retraced some of these losses after the Reserve Bank of India left its key interest rate unchanged. The central bank did increase the Cash Reserve Ratio by 0.5 percentage points to 7.0%, however investors judged this increase to be offset by the removal of the cap on funds the central bank can absorb each day from lenders.
Segment 2 – Conclusions
Conclusion – Segment – 3
The Indian stock market has been a beneficiary of investor’s high global risk appetite over the past four years. Each time risk appetite has been threatened, Indian equities have corrected sharply, reflecting the market’s quite volatile nature.
We are now going through another attack on global risk appetite. The MSCI India Index has declined 14% since the end of July, because investors have become concerned about deteriorating conditions in the US housing market and the impact this could have on the US and global economies. Risk is being priced in, and whether this proves to be temporary, as it was in February this year and May last year, or permanent - and thus signals the end of the four-year bull market - is difficult to determine. However, there are a number of factors that continue to support the Indian stock market.
Conclusion – Segment – 4
SUMMARY AND CONCLUDING REMARKS
This analysis is an attempt to uncover tools like E/P and PBV ratios to forecast longer horizon average market returns in emerging equity markets. We pool market averages of E/P and PBV for all emerging equity markets and try to see if they are related with 3, 6 and 12-month future returns. First, we rank the pooled observations with respect to E/P (PBV) and group them into quintiles. When we relate grouped E/P (PBV) values to future returns, we find that returns are higher after observing a high E/P (low PBV) in a market. Two sets of econometric tests are invoked to test the statistical relationship between E/P, PBV and future returns. Initially, we employ methodology to control for worldwide risk in an international CAPM framework. Next, we undertake a time series - cross sectional estimation of international CAPM models. Although FM method does not provide significant coefficients, E/P and PBV appear to predict future returns in pooled estimation. However, explanatory powers are very low in shorter return horizons. The fact that fundamental variables are related with future returns in less developed, diverse markets have strong implications for asset pricing in general. These variables have been shown to explain cross section of expected returns in developed markets. Yet they do not easily lend themselves to a model of capital market equilibrium; such findings are still regarded as an empirical regularity yet to be explained. Similar phenomenon in emerging equity markets is not therefore very puzzling. In terms of forecasting ability, the relationship between E/P, PBV and future returns are encouraging, but not very promising for the potential investor. One has only got to consider the low explanatory power of the models estimated in this study.
Conclusion – Segment – 5
SUMMARY AND CONCLUDING REMARKS
Analysis in return generating functions indicates the shortcomings of CAPM due to its too much dependence on one-single factor. On the other hand, the major shortcoming in case of APT is that the factors determining the asset returns are not associated with economic variables. The empirical models brought out by select analysts linking certain macro economic variables to asset returns found using insufficient number of variables as well not able to find any superior performance over the traditional CAPM and the APT.
The purpose of the present analysis is to explore into the role being played by a good number of macro economic variables when reduced into a manageable number of economic factors. Thus the study is likely to incorporate a multifactor return generating process into the traditional CAPM such that the resulting model is capable of directly utilizing the macro-economic variables in defining factors.
The Analysis observes that at least three very significant factors likely to influence the returns of assets during the employed data period. 1. The first factor encompasses economy-wide variables like industrial production, agricultural production, interest rate and money supply as well foreign exchange reserves, etc. 2. The second factor characrises by inflation in its different manifestations. 3. The third factor concentrates on industrial production. Interestingly the volume of turnover in two major stock exchanges found a place in the estimated factors indicating the role of demand and supply forces at market ring. The risk – return relationship is tested for individual scrips as well as etaranked portfolios using the sample of BSE-100 companies and BSE-SENSEX as market proxy for the latest 60 months data ending December 2007. The systematic risks corresponding to the factors are found properly priced in all the three models, the traditional CAPM, three-factor Macro economic Factor model and the Five-factor APT. On the basis of R2 value the Economic-factor model and the APT found to better explain the relationship than the traditional CAPM. The efficiency of the three models tested by using the forecasting errors. While the traditional CAPM is found overestimating the returns the Macro-economic factor model as well as the five-factor APT found underestimating the actual returns. However, the standard deviations of the errors are found relatively smaller in factor model thus justifying the present analysis.
Segment 3 – MSCI Index
MSCI INDEX - MSCI India Index and MSCI & MSCI India Total Return Index
Global Evolution of Indian Equities:
Except as otherwise noted, all information regarding the Index provided in this pricing supplement is derived from MSCI or other publicly available sources. Such information reflects the policies of MSCI as stated in such sources, and such policies are subject to change by MSCI. We do not assume any responsibility for the accuracy or completeness of such information. MSCI is under no obligation to continue to publish the Index and may discontinue publication of the Index at any time. The Index is a free float-adjusted market capitalization index that is designed to measure the market performance, including price performance and income from dividend payments, of Indian equity securities. The Index is calculated on a net basis, approximating the minimum possible dividend reinvestment (dividends are reinvested after deduction of withholding tax, using the rate applicable to nonresident individuals who do not benefit from double taxation treaties). As of October 17, 2007, the Index was comprised of the top 62 companies by market capitalization listed on the National Stock Exchange of India (the “NSE”). The Index is calculated by MSCI and is denominated in U.S. dollars. Securities eligible for inclusion in the Index include equity securities issued by companies incorporated in India. The shares of those companies are mainly traded on the NSE; however, in cases where such prices are not available due to the delisting from the NSE, official closing prices from the Bombay Stock Exchange (“BSE”) may be used. The NSE was established at the behest of the Government of India in November 1992, and the capital markets segment-commenced operations in November 1994. As of the end of September 2007, there were 1,319 companies listed on the NSE. Trades executed on the NSE are cleared and settled by a clearing corporation, the National Securities Clearing Corporation Limited, which acts as a counter party and guarantees settlement. The weighting of a company in the Index is intended to be a reflection of the current importance of that company in the market as a whole. Stocks are selected and weighted according to the same consistent methodology that is applied to all MSCI Indices, as described below. The reason for a company being heavily weighted reflects the fact that it has a relatively larger market capitalization than other, smaller Index Components. The Index Components are frequently reviewed to ensure that the Index continues to reflect the state and structure of the underlying market it measures. The composition of the Index is reviewed quarterly every January, April, July and October. As of October 17, 2007, the Index had a market capitalization of approximately $252.8 billion. As of such date, the top 50 Index Components were as follows (in alphabetical order):
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ABB India
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ACC
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Aditya Birla Nuvo
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Ambuja Cements
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Ashok Leyland
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Asian Paints
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Axis Bank
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Bajaj Auto
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Bharat Electronics
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Bharat Forge
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Bharat Heavy Elec.
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Bharat Petroleum
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CIPLA
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Dish TV India
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Dr Reddy’s Lab.
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Gail India
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Glaxosmithkline Phar
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Glenmark Pharma
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Grasim Industries
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HDFC Bank
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Hero Honda Motors
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Hindalco Industries
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Hindustan Petroleum
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Hindustan Unilever
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HDFC
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| ICICI Bank |
Indiabulls Finance Service |
Indiabulls Real Estate |
Indian Hotels Co |
Indian Petrochemicals |
| Infosys Technologies |
Infrastructure Dev Fin |
ITC |
Jaiprakash Assoc. |
Jindal Steel & Power |
| Kotak Mahindra Bank |
Larsen & Toubro |
MTNL |
Mahindra & Mahindra |
Maruti Suzuki India |
| Nestle India |
ONGC |
Ranbaxy Laboratories |
Reliance Capital |
Reliance Comm. |
| Reliance Energy |
Reliance Industries |
Satyam Computer |
Siemens India |
State Bank of India |
| Sun Pharmaceutical |
Tata Consultancy |
Tata Motors |
Tata Power Co |
Tata Steel |
| Ultratech Cement |
Unitech |
Videocon Industries |
VSNL |
Wipro |
| ZEE Entertaiment |
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What is MSCI Index?
Definition: MSCI IndexAn index created by Morgan Stanley Capital International (MSCI) that is designed to measure equity market performance in global emerging markets. Now, The Indian equities performance measured through MSCI India Index and MSCI India Total Return Index globally. The Emerging Markets Index is a float-adjusted market capitalization index. As of May 2005, it consisted of indices in 26 emerging economies: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, Turkey and Venezuela.
The MSCI Indices
The MSCI Indices, of which the Index is one, were founded in 1969 by Capital International S.A. as the first international performance benchmarks constructed to facilitate accurate comparison of world markets. Morgan Stanley acquired rights to the Indices in 1986. In November 1998, Morgan Stanley transferred all rights to the MSCI Indices to MSCI; a Delaware corporation of which Morgan Stanley is the majority owner and The Capital Group of Companies, Inc. is the minority shareholder. The MSCI single country standard equity indices have covered the world’s developed markets since 1969, and in 1988, MSCI commenced coverage of the emerging markets. The Index was launched on December 31, 1992. Local stock exchanges traditionally calculated their own indices that were generally not comparable with one another due to differences in the representation of the local market, mathematical formulas, base dates and methods of adjusting for capital changes. MSCI, however, applies the same criteria and calculation methodology across all markets for all single country standard equity indices, developed and emerging. MSCI’s single country standard equity indices generally seek to have 85 per cent of the free float-adjusted market capitalization of each industry group in each country. The MSCI single country standard equity indices seek to balance the inclusiveness of an “all share” index against the replicability of a “blue chip” index. The MSCI value and growth indices are subsets of the MSCI single country standard equity indices and seek to target approximately 50 per cent of the market capitalization represented by the underlying standard equity index for each country.
MSCI Single Country Standard Equity Indices
Weighting
Effective May 31, 2002, all single-country MSCI equity indices are free-float weighted, i.e., companies are included in the indices at the value of their free public float (free float, multiplied by price). MSCI defines “free float” as total shares excluding shares held by strategic investors such as governments, corporations, controlling shareholders and management, and shares subject to foreign ownership restrictions. MSCI’s single country standard equity indices generally seek to have 85 per cent of the free float-adjusted market capitalization of a country’s stock market represented within each industry group, within each country.
Regional Weights
Market capitalization weighting, combined with a consistent target of 85 per cent of free float adjusted market capitalization, helps ensure that each country’s weight in regional and international indices approximates its weight in the total universe of developing and emerging markets. Maintaining consistent policies among MSCI developed and emerging market indices is critical to the calculation of certain combined developed and emerging market indices published by MSCI.
Selection Criteria
To construct relevant and accurate equity indices for the global institutional investor, MSCI undertakes an index construction process that involves: (i) Defining the equity universe; (ii) adjusting the total market capitalization of all securities in the universe for free float available to foreign investors; (iii) classifying the universe of securities under the Global Industry Classification Standard (the “GICS”); and (iv) selecting securities for inclusion according to MSCI’s index construction rules and guidelines.
a) Defining the Universe. The index construction process starts at the country level, with the identification of all listed securities for that country. Currently, MSCI creates equity indices for 50 global country markets. MSCI classifies each company and its securities in only one country. This allows securities to be sorted distinctly by their respective countries. In general, companies and their respective securities are classified as belonging to the country in which they are incorporated. All listed equity securities, or listed securities that exhibit characteristics of equity securities, except Investment trusts, mutual funds and equity derivatives are eligible for inclusion in the universe. Shares of non-domiciled companies generally are not eligible for inclusion in the universe.
b) Adjusting the Total Market Capitalization of Securities in the Universe for Free Float. After identifying the universe of securities, MSCI calculates the free float-adjusted market capitalization of each security in that universe using publicly available information. The process of free float adjusting market capitalization involves: (i) defining and estimating the free float available to foreign investors for each security, using MSCI’s definition of free float; (ii) assigning a free float adjustment factor to each security; and (iii) calculating the free float-adjusted market capitalization of each security.
c) Classifying Securities Under the GICS. In addition to the free float-adjustment of market capitalization, all securities in the universe are assigned to an industry-based hierarchy that describes their business activities. To this end, MSCI has designed, in conjunction with Standard & Poor’s, the GICS. This comprehensive classification scheme provides a universal approach to industries worldwide and forms the basis for achieving MSCI’s objective of reflecting broad and fair industry representation in its indices.
d) Selecting Securities for Index Inclusion. In order to ensure a broad and fair representation in the indices of the diversity of business activities in the universe, MSCI follows a “bottom-up” approach to index construction, building indices up to the industry group level. The bottom-up approach to index construction requires a thorough analysis and understanding of the characteristics of the universe. This analysis drives the individual security selection decisions, which aim to reflect the overall features of the universe in the country index. MSCI targets an 85 per cent free float-adjusted market representation level within each industry group, within each country. The security selection process within each industry group is based on the careful analysis of: (i) each company’s business activities and the diversification that its securities would bring to the index; (ii) the size (based on free float adjusted market capitalization) and liquidity of the securities of the company; and (iii) the estimated free float for the company and its individual share classes. MSCI targets for inclusion the most sizable and liquid securities in an industry group. MSCI generally does not consider securities with inadequate liquidity, and/or securities that do not have an estimated free float greater than 15 per cent. Exceptions to this general rule are made only in significant cases, where exclusion of a security of a large company would compromise the index’s ability to fully and fairly represent the characteristics of the underlying market.
Free Float
MSCI defines the free float of a security as the proportion of shares outstanding that are deemed to be available for purchase in the public equity markets by international investors. In practice, limitations on free float available to international investors include: (i) strategic and other shareholdings not considered part of available free float; and (ii) limits on share ownership for foreigners. Under MSCI’s free float-adjustment methodology, a constituent’s inclusion factor is equal to its estimated free float rounded up to the closest 5 per cent for constituents with free float equal to or exceeding 15 per cent. For example, a constituent security with a free float of 23.2 per cent will be included in the index at 25 per cent of its market capitalization. For securities with a free float of less than 15 per cent that are included on an exceptional basis, the estimated free float is adjusted to the nearest 1 per cent.
Prices and Exchange Rates
Prices
The prices used t
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