A sector-based perspective of the Indian equity market indicates that as of end-2023, most valuation premiums were high in historical terms and relative to emerging markets (EM).
These sectors also offered an opportunity set with lower exposure to state-owned enterprises (SOEs) compared to sectors in other EM, say MSCI analysts in a sector note published earlier in February. “These sector-based insights may inform portfolio-construction decisions for investors seeking to add exposure to the Indian equity market.”
Since 2000, the MSCI India Index has provided higher risk-adjusted returns versus the MSCI Emerging Markets Index.
MSCI analysts say the relative outperformance was primarily driven by the financial sector. Between January 2000 and December 2023, financials were the best-performing sector in the MSCI India Index on an absolute basis, with its weight growing to 26% with 27 constituents.
As of December 2023, the second-largest sector was information technology (IT), with close to a 13% weight and nine constituents.
The India index boasts the third-highest exposure to IT among EM, according to analysts. Taiwan had the greatest exposure to the IT sector, followed by Korea and India.
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The MSCI India Index also bears limited exposure to SOEs, which are often concentrated in sectors with strategic importance for the state, says MSCI. “The ownership structure of an SOE could be a source of risk compared to a privately owned enterprise, depending on the SOE’s governance structures and policies.”
As of Dec 31, 2023, the MSCI India Index had fewer SOEs (18% of constituents) compared to the MSCI Emerging Markets Index (34%).
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The financial sector had the most SOEs (seven) with a market capitalisation of US$144 billion ($193.74 billion), 21% of the sector’s market cap, compared to SOEs composing 59% of EM financials.
The highest proportion of market cap (54%) in SOEs in India was in the utilities sector, compared to 77% in EM.
Notably, the MSCI India Index had SOEs in only six sectors compared to the MSCI Emerging Markets Index, which had SOEs in all sectors.
Higher returns, higher volatility
That said, investors must be able to stomach higher volatility in exchange for higher returns, adds MSCI.
Comparing the annualised risk and returns of the MSCI India, Emerging Markets and World Indexes, almost all Indian sectors earned higher absolute returns — but at the cost of higher risk — relative to sectors in EM and developed markets (DM).
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The risk was especially high in real estate and communication services. Stocks in India’s consumer staples and healthcare sectors had lower volatility compared to the parent index.
India’s real estate and communication services sector indexes had the lowest average number of constituents over the sample period, resulting in concentration risk, says MSCI.
That said, the only exception was communication services, add the analysts. “In all three markets, the communication services sector indexes underperformed the respective parent index.”
Most sector valuations rich at end-2023
Comparing sector valuations across markets and also relative to their longer-term averages can be an important reference point for investors, say MSCI’s analysts. This could help them make decisions about whether to rotate in or out of a specific sector.
“We looked at the long-term price-to-earnings ratio (P/E) of India’s sectors relative to EM sectors and to their historical values. The MSCI India Index has traded at a valuation premium to EM for more than two decades.”
At the end of December 2023, interquartile ranges suggested “the same was true” for most sectors relative to their EM counterparts, say analysts.
“Current valuations are also above the top quartile of the distribution for most sectors, with the IT sector one of the exceptions. Most Indian equity-market sectors were trading at forward P/Es above their historical long-term median and above their top-quartile range.”
