Less than a year ago, on the back of the Federal Reserve taper talks, India’s currency was sent into a tailspin on fears of its large current account vulnerabilities. For unhedged equity investors, this currency weakness detracted from their return and increased the volatility. During times of volatility, the focus tends to be less on individual company fundamentals and more on macroeconomic fears.
Opportunities typically present themselves during these times of heightened volatility and fear. When emotions can get in the way of making difficult portfolio allocations, WisdomTree’s rules-based process makes adjustments to portfolios based on strict readings of the underlying fundamentals.
At the most recent annual rebalance last September, the WisdomTree India Earnings Index (WTIND) added weight to companies with a high degree of sensitivity to the rupee (INR) because they were the greatest underperformers at the time. Their profits had yet to deteriorate, but the market was moving down on them. This process has also added significant value to the WisdomTree India Earnings Fund (EPI), which is designed to track WTIND, by focusing on these higher correlated securities, as of the most recent rebalance.
These companies have performed very well during the market and currency rebound, and this blog post will break down the performance of stocks in WTIND, based on their correlation to the rupee. The key: Stocks most sensitive and more correlated to the rupee have gone up the most, and WTIND had more weight than traditional indexes in these stocks that have higher correlations to the rupee.
Rupee Sensitivity
• High Correlation Over-Weight Led Outperformance – WTIND’s over-weight exposure to the highest correlation bucket of stocks added more than 8% of outperformance compared to the MSCI India Index. This is impressive considering it accounted for more than half the total 15.7% outperformance during the period.
• More Weight in Higher Correlated Stocks – The WTIND had almost 2x more weight in firms with the highest rupee sensitivity and almost two-thirds of its weights in firms within the highest two correlation buckets. WTIND is currently over-weight the Financials and Energy sectors and under-weight Information Technology and Consumer Staples. Over the past three years, the former sectors showed a higher degree of correlation than the latter sectors.
• Higher Correlated Firms Outperformed – Firms within the highest quartile outperformed firms in the lowest quartile by around 60% within both WTIND and MSCI India. Although the performance differentials among quartiles for the indexes were similar, WTIND was able to outperform over the period as a result of its over-weight to stocks within the highest correlation quartiles.
Weighting by Earnings Focuses on Lower Price-to-Earnings (P/E) Ratios
In order to garner significant weights in the WTIND Index, the index methodology requires that a company grow its profits rather than increase its market capitalization. As a result, we can generalize the impact of the rebalance as follows:
• Typical Additions in Weight – Firms whose share prices may have performed poorly or stayed flat but whose earnings increased
• Typical Reductions in Weight – Firms whose share prices may have performed quite well but whose earnings growth was negative or flat