Amidst the buoyancy in the Indian equity capital markets, one important question has escaped attention: what is the annualised shareholder return for the MSCI India stock market index over the last 15 years?

Even with a tripling of India’s GDP since the end of 2007, and despite relative political stability, the Indian stock market has returned a mere 2.8 per cent annualised return in US dollars. By way of comparison, the MSCI World Index has returned three times this return over the same period.

Decomposing this 2.8 per cent annualised return, corporate earnings per share growth for Indian companies has barely grown 1.8 per cent per annum over the last 15 years, a reminder of the tenuous relationship between GDP growth and corporate profits. Add another 1 per cent per year which has accrued from dividends, and the story has been one of decidedly pedestrian returns.

For certain, starting points on valuations matter, so consider where we are today versus 15 years ago.

On an absolute basis, valuations are broadly where they were 15 years ago. On a relative basis, however, the valuation of the Indian equity market versus a benchmark of international companies has never been higher versus history. Should India trade at a premium given healthier growth prospects? Sure, it should. But the current premium did not even exist at the peak of the 2007 cycle, the last time such exuberance came to the fore. The disconnect in valuations is even more egregious in the small and mid-cap space.

Key takeaways

There are five implications for Indian equity investors.

First, the depreciation of the Indian rupee shaves off 4-5 per cent per annum from returns over extended periods of time. The rupee-dollar exchange rate, for example, has lost half its value from 40 to 80 over the last 15 years alone. Simply put, if you can earn a 10 per cent annualised return in US dollars, investing in international markets from a starting point like today (which corresponds to a ~15 per cent annualised return in rupees), you can double your capital every five years. I consider this to be an attractive return for an Indian investor. Why? Because such a return has been beaten only 20 per cent of the time in the last three decades over any five-year rolling period by the Indian index. com

Second, consider the benefits of diversification. The MSCI World Index outperformed MSCI India between 1993-2002, although the reverse happened between 2002-2007. Since the end of 2007, up until 2021, Indian markets have trailed. Adding international equities can serve as a powerful diversifier during a period in which the Indian equity market trails the global index (which has been roughly half the time over the last three decades on any rolling 5-year basis). Put differently, since the creation of the MSCI India index at the end of 1992, the Indian index returns of 8.5 per cent per annum in US dollar terms have just been able to keep up with the MSCI World index returns despite the massive re-rating in valuations seen for Indian companies. And this, despite a 11x increase in Indian GDP over this three-decade period.

Third, consider the composition of indices. The top ten stocks in India account for half the market, whereas the top stocks in the MSCI World index account for just 20 per cent of the market. This suggests that there is far greater room for an international fund manager to add value by simply buying the 30 best businesses globally at reasonable valuations, which Indian investors simply cannot gain access to in one place. Investing in monopolies/ duopolies within the cutting-edge semiconductor, software, and global professional information services sector, is something Indian investors cannot gain access to by solely investing in Indian equities.

Fourth, investors should be wary of “home bias”, which refers to the tendency to invest one’s portfolio entirely in domestic equities, ignoring the benefits of diversification. This bias is driven more by patriotic emotions rather than objectivity: why else would only ~1% of Indians’ total savings pool be invested in international equities?

Fifth, when a rising tide of liquidity powered by domestic savings cannot gain access to international equities due to regulatory strictures around gaining access to international funds, such policies can result in booms and busts in the local equity market. Look no further than China to understand how policies designed to protect individual and national interests can sometimes have exactly the opposite effect. During periods of extreme valuation differentials such as today, investors should seek access to alternatives. The last three decades have clinically demonstrated why.

In conclusion, today is a great time to invest in some of the best businesses globally. This is not to say that India is not a great investment destination. It most certainly is. But geographic diversification is much like insurance: you should seek it when you feel you least need it.

The author is Founder & Chief Investment Officer, Lyptus Capital

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