Historically, many investors have been interested in the rupee because it is trading at a significant discount to its long-term purchasing power parity. In fact, the rupee is currently undervalued by 62%.4 However, this discount will likely begin to fade in the long run. A more immediate reason why we are constructive on the rupee is that the short-term interest rates in India are currently at 8%.5
Since the WisdomTree Indian Rupee Strategy Fund (ICN) seeks to provide its exposure to the rupee through forward currency contracts, foreign investors are able to capture the higher interest rates available to Indian investors. In our view this 8% interest rate, the third-highest across all emerging markets,6 can serve as a buffer to investor returns, should the Indian rupee decline in value. As we mentioned in an earlier blog post, the cost of hedging the rupee can largely be attributed to this interest rate factor. As a result, investors who take a long position in the rupee are being compensated a large portion of this 8% interest rate differential.7
Indian Asset Class Risk vs. Return
For definition of terms in the chart, please visit our Glossary.
As shown in the table above, Indian rupee currency forwards have provided the best Sharpe ratios across nearly all Indian assets—including stocks and bonds—since the local markets bottomed out in August 2013.8 In addition to its comparatively attractive risk-adjusted returns, this asset class allows investors to take a position on Indian markets with approximately half the volatility of Indian equities, the most traditional means of accessing India markets for U.S.-based investors.
Conclusion
The Indian election entails a fair degree of uncertainty. While markets remain hopeful that a change in India’s political winds will ultimately lead to profit, we believe that the rupee represents the most attractive means of expressing a bullish view on the Indian economy.
1Source: EPFR Global, as of 4/9/14.
2Source: Bloomberg, 12/31/13–3/31/14.
3Based on the price/earnings ratio of the MSCI India and the MSCI Emerging Markets indices.
4Source: IMF, as of 3/31/14.
5Source: Bloomberg, as of 3/31/14.
6Sources: Bloomberg, WisdomTree, as of 3/31/14.
7In order to provide investors with an idea of the income potential of investments in forward currency contracts, WisdomTree provides them with an embedded income yield. The embedded income yield for ICN was 7.81% as of 3/31/14.
8The Indian rupee and MSCI India Index traded at their weakest levels in over 4 years on 8/28/13.
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. This Fund focuses its investments in India, thereby increasing the impact of events and developments associated with the region, which can adversely affect performance. Investments in emerging or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments.
Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations. Derivative investments can be volatile, and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions. As this Fund can have a high concentration in some issuers, the Fund can be adversely impacted by changes affecting those issuers.
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