In addition to seeing India’s spacecraft landing on the moon last year, the country also outperformed emerging markets. The IMF expects its GDP growth to reach 6.7% in the 2023–2024 fiscal year versus 3.1% for the global economy and 4.2% for emerging market and middle-income economies in 2023. India’s equity market has mirrored these strong fundamentals, becoming the world’s fourth biggest in January when MSCI India Index hit an all-time high.
A range of structural drivers have been pushing India’s outperformance, including positive demographics, strong internal consumption growth, digital innovation and economic challenges in other markets. While this growth makes media headlines, investors should note that equity returns have not been even across all business sectors.
Most Indian sectors have delivered higher absolute returns versus other emerging markets, beating developed markets in many cases, too. However, that performance comes at the cost of higher risk levels, underscoring the opportunity that bottom-up stock selection offers for adding active returns.
Financials drive absolute returns
For over two decades, the MSCI India Index has traded at a valuation premium to Emerging Markets Index driven by almost all the sectors. While almost all sectors have outperformed, MSCI Markets and Investment Insights analysts Rohit Gupta and Dinank Chitkara analysed the MSCI India Index to understand where risk and reward may intersect within Indian equities.
The methodologies for this analysis included a factor model designed for India to help estimate equity risk, and a cross-sectional volatility (CSV) measure. In simple terms, CSV is given by the standard deviation of a set of asset returns over a single time period, which can represent the opportunity to outperform a benchmark. Over the last two decades, CSV analysis revealed that bottom-up stock selection offered opportunities to add active returns.
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In MSCI’s analysis, India’s financial sector emerged as a cornerstone of absolute returns for investors since the year 2000. However, the higher absolute returns come at the cost of higher risk. Notably, risk was particularly high in the real estate and communication services sectors.
MSCI also compared Global Industry Classification Standard (GICS) sector exposures in other markets within Emerging Markets Index and found that, as with India, the financial sector is often the largest exposure. This may contrast somewhat with media headlines that emphasise innovation, particularly in IT, as a growth driver.
Among emerging markets, India ranks third for IT exposure. The only markets offering more IT are Taiwan and Korea. However, Indian IT sector is concentrated with only Software and Services stocks compared to a more diversified IT sector exposure within the Emerging Market Index.
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Risk factors
MSCI’s study highlights how a sectoral investment approach could unveil risks and opportunities in the Indian market.
While the country’s business sectors often deliver higher absolute returns than counterparts in other emerging or even developed markets, they can also be subject to heightened volatility.
Market demand, regulatory changes and regional economic conditions often contribute to market volatility but a low number of constituents in a given sector can also introduce concentration risk, amplifying the impact of adverse conditions across small sets of assets. This may be a factor for the real estate and communication services sector in India, as they had the lowest average number of constituents over the sample period.
The year ahead
In 2024, macro factors are again set to create a compelling case for Indian equities and taking a sector-based approach could help identify potential areas of risk and outperformance, hence informing portfolio-construction decisions for investors seeking to add exposure to the Indian equity market.
To find out more about investing in emerging markets, please visit MSCI's webpage.
