Everybody knows that India is an expensive market. But just how pricey is it compared to other markets? The S&P/Citigroup Global Equity indices show that, according to IBES (a global database of analysts’ forecasts), the Indian market was valued at a one-year forward price-earnings multiple of 25.62 as on 31 December 2007. That’s the third highest valuation for all the markets covered by the group of indices. The highest valuation among emerging markets is for Morocco, which shows a one-year forward multiple of 30.11. China is third at a multiple of 23.46. (That’s assuming Nigeria’s multiple of 185.71 is a statistical quirk). Among the developed markets, Slovenia, at a multiple of 31.79, stands out in solitary splendour.
Of course, the high valuation is also a reflection of a high return on equity (RoE). India’s RoE is 19.77, according to the S&P/Citigroup numbers, well above China’s 15.31. But then, several other countries, including South Africa and the UK, have higher RoEs but much lower valuations.
Is the case against India on the ground of high valuations an open and shut one? Not really. If you took the valuation ratios as on 31 January 2007, India’s one-year forward PE, at 20.07, was higher than all other markets except for Morocco among emerging markets and except Slovenia and Luxembourg, among developed markets. Yet that didn’t stop the Indian market from giving one of the highest returns among all markets last year. In local currency terms, the S&P/Citigroup index for India delivered a 59.4% return in 2007, much higher than the supposedly “cheaper” markets. Even more surprising is the fact that Slovenia, the most expensive market in the world in terms of the one-year forward PE in January last year, gave a return of 67.61%. Slovenia’s RoE at the time was a measly 8.28%. Clearly, 2007 was a year when momentum trumped value. Recent research by Credit Suisse analysts Nilesh Jasani and Arya Sen points out that price momentum has been the most effective quantitative strategy in the Indian market. They say that picking stocks with price momentum has provided returns that “were 25-30% per annum in excess of the Sensex since 2001”. Elaborating further, they point out that a strategy based on picking the top 10 price performers of the previous month gave returns of 130.1% in 2007, compared with 47.1% returns for the Sensex.
The Securities and Exchange Board of India (Sebi) is introducing new products in the derivatives market in quick succession. Close on the heels of mini contracts on equity indices, the regulator has approved long-dated options, with maturity up to three years.
According to reports, contracts on a volatility index would also be made available soon. Left to the market, these products would have hit Indian shores months ago, simply because market participants have been demanding it for a while now. Nevertheless, it’s commendable that Sebi is quickly implementing proposals made by its derivatives market review committee.
Considering that even three-month contracts aren’t liquid in India, it may look rather ambitious to launch three-year contracts. But a number of long-term investors look for long-term hedging products such as long-dated options before making large buy decisions. Such investors had to rely on over-the-counter (OTC) products offered in overseas markets by foreign brokers, who in turn covered their positions by taking opposite positions in the Indian derivatives market. The recent ban on participatory notes with derivatives as underlying, however, would have curbed such activity. It may be a while before structured OTC products can be offered in the Indian markets, but for the moment at least, long-term hedges can be made using the long-dated options.
The ban on participatory notes has led to a drop in foreign institutional investor participation—their share in turnover has dropped from around 12% before the restrictions to 8% soon after the ban was imposed. Products such as long-dated options, which cater to institutional investor’s needs, could help increasing their share.
Having said that, OTC products must also be launched soon for institutional investors to participate in full measure.
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