The inclusion of Indian bonds in a major emerging markets index is great news for the country — but that’s almost by-the-bye for emerging markets managers. Rather, their attention is on the onerous nature of operating in the market, and what India's inclusion means for the countries that will be making way for the new kid on the block.
Starting later this month, certain India sovereign bonds will be included in the emerging markets index run by J.P. Morgan. The 23 securities that are expected to be admitted to the index have a notional value of about $330 billion, and will be included in phases over 10 months to reach a 10% maximum weighting.
While any inclusion is positive for investors and the market itself, with increased diversification across the index, the well-signposted and long process of India’s inclusion isn’t sparking much excitement among emerging markets managers — who warned that those hoping to get invested immediately may need to think again.
“We would expect that for our index fixed-income desk, India’s inclusion in the J.P. Morgan index will be the biggest individual index-related event in 2024,” said Lee Collins, head of index fixed income at Legal & General Investment Management.
The $1.48 trillion money manager has been investing in the Indian government bond market for more than 2½ years, since it launched its India bond exchange-traded funds, “and thus we are fortunate to have the practical experience that many of our peers will not have as of today,” he said.
Nightmare opening accounts
One source described the process of opening an onshore account in India — necessary for trading Indian bonds — as a “nightmare,” while others agreed that it was a challenging situation that somewhat dampens excitement.
“It is quite an onerous process to open (an account in the) onshore market, and then actually trade,” said Mark Evans, an analyst in Ninety One’s fixed income team, responsible for Asian bond and currency markets. “I think people focus a lot on the fact that it takes a long time to open the accounts and paperwork — but it’s not just that: It’s the bit once all that is done, the physical trading of Indian bonds thereafter (is) where it gets quite tough,” he said. “It’s a long process — (investors) need resources to be able to run this. We have a whole team dedicated” to accounts opening, he added. Ninety One had $159.2 billion in AUM as of March 31.
The hope is that India will ease the process over the coming 10 months before it hits its 10% weighting, when “all of us (will be) trying to access India at the same time,” Evans said. There are test trades ongoing, with traders “trying to iron out the cracks, and the hope is that over time, a lot of these difficulties that managers are facing are ironed out in that period.” Foreign investors, the local regulator and participants in the local bond market need “to be fully aware of the difficulties faced by small, medium and large-sized asset managers,” Evans added.
And investors that think they still have time to get involved ahead of India’s inclusion may be left disappointed, and need to have a Plan B.
“There will also be some investors who may still be opening accounts and completing the onboarding processes to be able to trade Indian government bonds. Some of these probably won’t be ready in time for the end of June and so they will be preparing alternative options to ensure they can gain exposure,” LGIM’s Collins said.
Two options are to buy rupee-denominated supranational bonds, which don’t require domestic accounts and settle in U.S. dollars, or to invest via an ETF, Collins added.
Rong Ren Goh, portfolio manager, fixed income at Eastspring Investments, said opening onshore accounts to trade Indian bonds “can still take notoriously long — we are talking about several months.”
Another disadvantage is the withholding tax that foreign investors are subject to in India. Currently set at up to 20%, this tax could discourage investors from going directly and instead go via swaps — although sources added that leaves them open to basis risk.
And the tax calculations on capital and coupon gains can also take longer than usual — “which can in turn affect the settlement cycle of bond proceeds and FX, cascading into trade and settlement failures,” Goh said. “These continue to be issues that investors will have to grapple with.” Eastspring Investments, part of Prudential PLC, has $239 billion in AUM.
Beyond specifics
Aside from the onerous process and tax implications of investing in India’s bond market, emerging markets managers are also concerned about the impact its admission to the index will have on existing countries in the club.
“The impact could be bigger on those that lose — if a big weight is coming in at 10%, some others have to give (their weighting) up,” Carl Vermassen, portfolio manager in the emerging markets bond team at Vontobel Asset Management, which had 206.8 billion Swiss francs ($245.7 billion) in total assets under management as of Dec. 31.
Indonesia and China will remain at the 10% weighting they have enjoyed for some time. Malaysia and Brazil will see their weightings fall to about 9.5% and 9%, respectively, but the countries Vermassen will be watching is Poland — expected to fall to about 6.5% — and Thailand, which drops to about 8%, he said.
Ninety One’s Evans agreed that “for the rest of the emerging markets, the impact is more meaningful,” naming Thailand, Poland and also South Africa as bearing the brunt of India’s inclusion in terms of weighting, with those countries losing out of investment inflows due to the change. However, he doesn’t think it will be “destabilizing — I don’t think it’s a significant cannibalization” of those markets, he added.
Relative to China
But of course, there are pluses to adding India to the index.
Sources pointed out the attraction of India relative to China — in particular, when it comes to yields and tail risk associated with geopolitics.
Indian government bonds are yielding about 7%, vs. about 2% for China, and it is also “relatively low volatility,” Ninety One’s Evans said. “India will give relative amount of protection and a bit of yield. That does make including India more attractive for the asset class,” he said.
While there are similarities between China and India’s local fixed-income markets, particularly in relation to their deep investor bases, market liquidity and lower beta to global fixed income, there are attractive differences, said John Espinosa, portfolio manager for Nuveen’s global fixed-income team and sector lead for sovereigns.
“While China’s bond market is larger, we believe India’s greater yield differential, improving fiscal and inflation developments, and better geopolitical risk profile make India the more attractive investment of the two,” Espinosa said.
“Furthermore, given elevated geopolitical tensions between China and the West, we have observed foreign investor outflows away from the Chinese government bond markets over an extended period. We also note investors increasingly seek EM local bond benchmarks that exclude China, so the timing of the inclusion of India into such indices enhances diversification and yield for investors.” Nuveen has a total $1.2 trillion in assets under management.
Gustavo Medeiros, head of research at emerging markets specialist Ashmore, agreed that India "offers a much higher potential GDP growth than China" on a structural basis. "India has better demographics, debt profile and is better positioned in geopolitical terms," he said.
China's inclusion in the emerging markets index in 2018 "improved the volatility profile as ... China's monetary policy has had low correlation with the rest of the world," and Medeiros expects a similar impact on India. "But India offers better forward-looking fundamentals and higher yields, making it a much more exciting story," he said.
