At WisdomTree, we believe in the potential of India’s equity markets, especially since prime minister Narendra Modi’s Bharatiya Janata Party (BJP) victory in May of 2014. Thus far, there have certainly been strong gains—a fact we discussed in a prior blog. We were able to realize some strong gains by redistributing the sector weights of the WisdomTree India Earnings Index (WTIND) toward sectors that hadn’t performed as strongly, detailed further here.
All this is a function of WTIND’s unique, rules-based methodology, that redistributes weight toward stocks indicating strong profit growth relative to their share price performance.
WisdomTree feels that weighting by market capitalization, which does not weight, consider or rebalance back to any measure of economic importance of the underlying constituents, may not be the best approach for this particular strategy. Instead, we believe a disciplined strategy of anchoring allocations back to a measure of relative value, based on fundamentals such as dividends or earnings, can add value over time.
The Fundamental Difference
The WisdomTree India Earnings Index seeks to provide exposure to the profitable core market of India’s equities but to do so while maintaining sensitivity to valuation. To help achieve this, WisdomTree weights companies in the Index by the profits they generate, rather than their market cap, and rebalances back to profitability on an annual basis.
WisdomTree’s India Earnings Index rebalance process typically is driven by:
• Earnings Growth: Companies that grow their profits see their weight increased
• Relative Performance:
– Underperformers typically see their weight increased
– Outperformers often see their weight decreased
This process tends to shift weight to firms with lower price-to-earnings (P/E) ratios, as illustrated in the chart below: it compares the distribution of stocks by their P/E ratios in WTIND to that of widely followed market cap-weighted indexes that also measure the performance of India’s equities.
P/E Ratio and Weight Distribution
WTIND’s P/E ratio is approximately 14.0x—reflecting the 2014 Index screening—i.e., almost 25% lower than the 18.4x P/E ratio of the S&P CNX Nifty Index (Nifty Index) or the 18.6x P/E ratio of the MSCI India Index.1 The chart below provides a look at how the weight is distributed, to give a sense for why this lower P/E ratio is seen for the aggregate Index.