A spectre is haunting global markets—the spectre of inflation.
The latest storyline goes something like this: World growth is extraordinarily robust, which will lead to higher inflation, which in turn will mean higher interest rates. And since this rally has been founded on cheap money, so goes the argument, world economic growth will slow and profits will drop. These concerns have pushed up the yield on the US 10-year Treasury note beyond 5%, which has traditionally been a warning sign for the markets.
How valid are these fears? Well, consumer price inflation in the US is at 2.6%, compared with 3.5% a year ago. In Japan, it’s zero, compared with -0.1% a year ago. In the European Union (EU), it’s 1.9%, compared with the year-ago figure of 2.5%. But despite inflation being lower, long-term interest rates have moved higher in most places, although Japan is a big exception. The combination of lower inflation and higher long-term yields means real interest rates are now higher than they were a year ago.
The results in terms of GDP growth have been mixed. While US growth has slowed substantially, as has Japan’s, that’s been offset by high growth in the EU.
The World Bank recently forecast 4.7% growth for the global economy this year, down from 5.3% in 2006. However, growth in 2008 is expected to be 4.8%.
But if growth is supposed to slow down this year, why should inflation accelerate? As a matter of fact, the Reuters/Jefferies CRB index is currently around 8% lower than its year-ago level. Perhaps even more tellingly, the Economist’s poll of forecasters doesn’t indicate any signs of an expected pick-up in inflation in the US, Japan or Euroland either this year or the next.
The four-year bull run has been the result of a high-liquidity, low-inflation, not-too-hot, not-too-cold conditions best described by Goldilocks. So far, there are few signs of her reign coming to an end.
It’s quite uncommon for mutual fund (MF) companies to venture into the exchange-traded fund (ETF) space. Globally, the top two firms—Barclays Global Investors (BGI iShares) and State Street Global Advisors—dominate the market with more than 60% share. Both firms offer investors only ETFs. In fact, there are less than 100 ETF providers globally, which pales in comparison to the thousands of MF firms worldwide. This is easy to understand, as the management fee earned by ETFs is far lower than MFs.
Yet, this space now seems to be appealing to Indian MF companies. A number of them have filed for ETFs that track gold prices, sensing high demand because of India’s fixation with the metal.
Kotak Mutual Fund has gone a step further and filed for an ETF that tracks a banking index. That isn’t surprising. Benchmark Asset Management’s banking index ETF accounts for 95% of the industry’s assets.
The reason for investors? High interest in the banking index ETF is that some categories of investors such as foreign institutional investors (FIIs) have curbs on directly buying banking shares. This is because the Reserve Bank of India’s (RBI) limits for FII ownership have been breached in a number of public sector banks. Buying an ETF instead gives them a pure exposure to India’s banking sector, without flouting RBI rules. The shares are held in the name of the ETF company, but benefits of price appreciation and dividend accrue to the investor. It’s a neat arrangement where all concerned parties benefit. Even policy makers should be fine since voting rights are not held by foreign investors.
One fallout of Kotak’s entry in this space would be increased awareness for ETFs in the Indian market. The other is that there would be greater symmetry between demand and supply for banking stocks, which is currently distorted by low central bank limits.
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