US pension fund's index switch: Indian equity mkts set for $3.6 bn bonanza

Changing benchmark will trigger $3.6 bn inflows into domestic equities

A US federal government retirement fund’s decision to change its equity benchmark index for gaining international exposure is set to trigger a churn of $28 billion (Rs 2.3 trillion) across global equities, and India is expected to be a major beneficiary of the move. According to analysts, Indian equity markets may attract inflows of $3.6 billion (Rs 30,000 crore)  on account  of this  churn.

The Federal Retirement Thrift Investment Board (FRTIB), one of the US government’s main retirement funds with assets of over $600 billion, recently decided to switch the benchmark index it uses for investing in global equities from the MSCI EAFE index to the MSCI ACWI IMI ex USA ex China ex Hong index.

As of October 31, the FRTIB had invested $68 billion in the International Stock Index Investment Fund, which used MSCI EAFE as the benchmark.

The EAFE index comprises 21 developed markets across Europe, Australia, Asia and the Far East, but excludes the US and Canada. India is not part of this index. The MSCI ACWI IMI ex USA ex China ex Hong index, on the other hand, has a mix of developed markets (DMs) and emerging markets (EMs).

An analysis done by insight provider Brian Freitas of Periscope Analytics, who publishes on Smartkarma, shows Canada will be the biggest beneficiary of the switch with estimated inflows of $5.6 billion, followed by India ($3.6 billion) and Taiwan ($3.4 billion). The biggest losers could be DMs like Japan (estimated outflows of $3.9 billion), the United Kingdom ($3 billion), and France ($3 billion).

The US and China equities will not be impacted by the benchmark switch since both countries are either part of the old index or new. Hong Kong will be one of the worst impacted as it is part of the old benchmark but not the new one. Despite Japan, the UK and France being part of the new index, they will suffer outflows as their weighting stands to reduce.

“We estimate a one-way trade of $28 billion for the FRTIB due to the benchmark switch. This includes an increase in the number of countries and an increase in the number of stocks in all countries due to the inclusion of small cap stocks. There will be large outflows from a lot of developed markets with inflows to emerging markets,” said Freitas.

The switch to the new gauge will be implemented in multiple tranches over a four-month period, starting the next calendar year, to ease out volatility.

“If the benchmark switch is done in 16 tranches, there will not be a huge impact on any single stock, but the impact could increase with every subsequent tranche that is implemented,” Freitas added.

This is the first time India will be a recipient of FRTIB funds as the country was not part of the old index. Despite that, the impact will be relatively modest, as India’s weight is not among the top five, nor do any of the domestic stock features in the top 10 constituents’ list. The MSCI ACWI IMI ex USA ex China ex Hong Kong index is a very broad gauge with over 5,600 constituents.

With a market cap of nearly $4 trillion, the Indian market is the world’s fifth largest. But a relatively low public float and caps on overseas investments in several sectors have kept India’s weighting under check in several global indices historically. This has slowly changed over the past few years with sharp outperformance of domestic equities vis-à-vis other global equities. Also, India’s public float has increased following regulatory measures such as mandating listed companies to have at least 25 per cent public float, freeing up of investment legroom for overseas funds by the government, and advent of new-age companies with 100 per cent public float.

Currently, India’s weighting in the popular MSCI EM index is the second most after China, with the gap between the two narrowing over the last few years. A recent note by Axis Mutual Fund showed that India’s weighting in the MSCI EM index has moved from 6.4 per cent in 2013 to 16.2 per cent now. During the same time, China’s weighting has reduced from 42.5 per cent to 29.55 per cent.