EPI: Sticking To The Fundamentals Pays Off In India

seekingalpha06-21

urzine/iStock via Getty Images India's election results are out, and although the incumbent government has seen its majority reduced, Prime Minister Modi's coalition government has still won a record ...

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As I highlighted in my prior coverage of WisdomTree's 'all-cap' factor ETF, the India Earnings Fund (NYSEARCA:EPI) (see here and here), equities weren't priced all that aggressively relative to earnings (see performance attribution below); so it wasn't too surprising to me that the fund rallied through and post the election period. Zerodha Yes, a smaller majority means some of the more contentious reforms are now off the table, and that will cost India a percentage point or two of GDP growth. But there's enough supply side momentum, particularly from tax incentives and capex spending, to keep the country on a high-single-digit % real GDP growth path (>10% nominal), in my view. As one of the few equity markets in the world where GDP correlates with earnings, more economic growth should keep large-cap earnings growth chugging along at a steady low to mid-teens % pace for the years to come (even higher for the small/mid-caps). Strong fundamentals, combined with a reversal in foreign flows after the elections (note foreign investors are net sellers to date), offer a compelling setup for Indian equities in this post-election stretch. NDTV That said, in a post-election environment where certain stocks will no longer be priced for big reform benefits, a more discerning approach to capital allocation, particularly regarding earnings visibility, might pay a little more here. In this context, EPI's stock selection screen stands out, as it gives investors additional margin on quality and price across all segments of India's equity universe. Ahead of next month's budget, which could see some policymaking surprises by this newly elected government, EPI screens attractively as a vehicle to ride out any near-term uncertainties. Data by YCharts EPI Overview – More Size and Liquidity for the Go-to Indian Factor ETF The WisdomTree India Earnings Fund remains a fundamentally weighted index fund (tracking the WisdomTree India Earnings Index) built around key metrics such as profitability (trailing net income), liquidity (median daily dollar volume above $200k), and accessibility (stocks below foreign ownership limits). Its 0.85% expense ratio is also intact, which places it in between both US-listed factor ETF alternatives, Invesco's India ETF (PIN) (0.78%) and VanEck's India Growth Leaders ETF (GLIN) (0.87% net of waivers; 1.1% gross). WisdomTree The most notable change this quarter is the rise in EPI's managed assets to ~$3.5bn. While the added size hasn't translated into lower fees, it has added to EPI's liquidity advantage within the factor ETF universe – the current ~4bps bid/ask spread compares very favorably to 22bps for PIN and 45bps for GLIN. WisdomTree The relatively larger small/mid-cap allocation (74.0% large-cap, 19.6% mid-cap, and 6.4% small-cap) also continues to stand out; by comparison, PIN is focused almost exclusively on large-caps, while the only other Indian 'all-cap' factor ETF, GLIN, has a much lower small/mid-cap allocation at 18.6%.     Large-Cap Mid-Cap Small-Cap   WisdomTree India Earnings Fund 74.0% 19.6% 6.4%   VanEck India Growth Leaders ETF 80.2% 15.7% 2.9%   Invesco India ETF 98.1% 1.9% 0.0%   Click to enlarge Source: WisdomTree, VanEck, Invesco EPI Portfolio – Mostly Status Quo Heading into the Upcoming Rebalance Relative to last quarter, EPI's portfolio makeup has been mostly consistent. Sector-wise, Financials is still top of the pile, albeit at a slightly lower 21.9%, while the more cyclical Energy (17.2%) and Materials (13.7%) sectors remain the fund's second and third-largest exposures, respectively. EPI is also heavily overweight both in Energy (+6%pts) and Materials (+3%pts) compared to MSCI India. While the most underweight are Consumer Staples (-5%pts) and Technology (-2%pts). WisdomTree At the single-stock level, the big change is that EPI has narrowed its portfolio down quite a bit to ~475 stocks (vs over 500 previously). That said, its top holdings, Reliance Industries (RLNIY), HDFC Bank (HDB), and ICICI Bank (IBN), are all virtually unchanged from last quarter. Tech services company Infosys (INFY) is still the fourth-largest holding, though it has ceded portfolio share to Mahindra & Mahindra and state-owned names like Coal India (3.1%) and State Bank of India (2.6%). Expect some changes at the Q3 rebalance, particularly for names on an earnings up/downswing; as stock selection will remain grounded in fundamentals, I wouldn't be too concerned. WisdomTree EPI Performance – Fundamental Weight is the Best Weight Performance-wise, few Indian funds can match the returns EPI has delivered through PM Modi's last two terms. Recent gains have been particularly impressive, with EPI's 11.0% year-to-date return boosting its overall one-year return to +37.9%. Zooming out, returns over the last five and ten years have also been peer-leading at +13.8% and +9.4%, respectively. By comparison, factor ETF alternative, the large-cap-focused PIN, continues to lag EPI over near and longer-term timelines. The other 'all-cap' Indian fund, GLIN, on the other hand, has slightly outpaced EPI on a one-year basis but lags over longer timelines. WisdomTree It's also worth noting that fundamentally weighted EPI has outperformed straightforward large-cap trackers like the iShares MSCI India ETF (INDA) and Franklin FTSE India ETF (FLIN) by a wider margin over virtually all relevant timelines. The fund's performance attribution points to a combination of allocation (sector/category weights vs. benchmark) and stock selection (equities held vs the benchmark) as key to this outperformance. In fact, EPI's fundamental-focused screen works so consistently that attribution this year is only negative in one sector - Communication Services (-3bps vs MSCI India). WisdomTree EPI's screen also results in lower portfolio multiples than comparable ETFs. Despite its small/mid-cap allocation, the fund is priced multiple turns below most other India tracker funds at ~18x forward P/E and ~12x cash flow – very reasonable relative to underlying growth. Thus, more price-sensitive investors should find lots to like here. Income investors, on the other hand, should look elsewhere, as the sub-1% distribution yield likely won't be increasing anytime soon.   Portfolio Valuation Multiple (X)   Price/Earnings 19.8   Estimated Price/Earnings 18.3   Price/Book 3.5   Price/Sales 1.9   Price/Cash Flow 12.0   Click to enlarge Source: WisdomTree On the flip side, EPI's wide tracking error (i.e., the gap between fund and index return) is an issue, particularly in bull markets. This is less the fault of the manager than the many 'hidden' costs associated with investing in India (e.g., capital gains taxes, transaction costs, currency changes, etc.). More so for factor ETFs like EPI, which require more management than a regular passive fund. The good news, though, is that the delta has narrowed this year (one to two percentage points vs the WisdomTree India Earnings Index benchmark), so investors have still come away with healthy % gains. WisdomTree Sticking to the Fundamentals Pays Off in India  India remains a great place to be invested in. But in the aftermath of a surprise election result, a more discerning investing approach may be warranted. In this regard, EPI, a factor ETF that incorporates a fundamental overlay to stock selection across all segments of the equity universe, stands out as a great vehicle to ride the next leg of India's growth story.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2445278832"}