US Federal Retirement Fund's Index Shift To Trigger $3.6 Billion Inflows For India

The decision by a US federal government retirement fund to modify its equity benchmark index for international exposure is expected to initiate a shift of $28 billion (Rs 2.3 trillion) across worldwide equities, with India predicted to be a major beneficiary of this move.

Analysts suggest that this shift could lead to the Indian equity markets attracting inflows amounting to $3.6 billion (Rs 30,000 crore).

The Federal Retirement Thrift Investment Board (FRTIB), a primary retirement fund for the US government, with over $600 billion in assets, recently decided to change its global equities investment benchmark index. The transition is from the MSCI EAFE index to the MSCI ACWI IMI ex USA ex China ex Hong index.

As of the end of October, the Federal Retirement Thrift Investment Board (FRTIB) had invested in the $68 billion in the International Stock Index Investment Fund, utilising the MSCI EAFE as its benchmark.

The EAFE index includes 21 developed markets spanning Europe, Australia, Asia, and the Far East, but it does not incorporate the US, Canada, or India. On the other hand, the MSCI ACWI IMI ex USA ex China ex Hong index encompasses a blend of developed markets (DMs) and emerging markets (EMs).

An analysis done by insight provider Brian Freitas of Periscope Analytics, who publishes on Smartkarma, shows Canada will be the biggest beneficiary of the switch with estimated inflows of $5.6 billion, followed by India ($3.6 billion) and Taiwan ($3.4 billion). The biggest losers could be DMs like Japan (estimated outflows of $3.9 billion), the United Kingdom ($3 billion), and France ($3 billion).

The switch in benchmark will not affect the equities in the US and China as these countries are included in either the old or new index. However, Hong Kong will face significant impact as it was part of the old benchmark but is excluded from the new one. Even though Japan, the UK, and France are incorporated in the new index, they are likely to experience outflows due to a prospective reduction in their weighting.

“We estimate a one-way trade of $28 billion for the FRTIB due to the benchmark switch. This includes an increase in the number of countries and an increase in the number of stocks in all countries due to the inclusion of small cap stocks. There will be large outflows from a lot of developed markets with inflows to emerging markets,” said Freitas, Business Standard reported.

The transition to the new gauge will be carried out in several stages over a period of four months, beginning the upcoming calendar year, to mitigate volatility.

“If the benchmark switch is done in 16 tranches, there will not be a huge impact on any single stock, but the impact could increase with every subsequent tranche that is implemented,” Freitas added.

This is the first time India will be a recipient of FRTIB funds as the country was not part of the old index. However, the effects are likely to be somewhat modest, given that India's weight doesn't rank in the top five, and none of the domestic stocks appear in the list of top 10 constituents.

The MSCI ACWI IMI ex USA ex China ex Hong Kong index is an extensive measure encompassing over 5,600 constituents.

The Indian market, with a nearly $4 trillion market cap, ranks as the fifth largest globally. However, due to a comparatively low public float and restrictions on foreign investments in numerous sectors, India's representation in many global indices has historically been limited.

This scenario has gradually shifted in recent years, thanks to the significant outperformance of domestic stocks compared to other global equities.

Moreover, regulatory measures like requiring listed companies to maintain a minimum of 25 per cent public float, the government's move to allow more room for foreign funds to invest, and the emergence of new generation companies with 100 per cent public float have all contributed to an increase in India's public float.

At present, India holds the second highest weighting in the widely recognized MSCI EM index, trailing only behind China, and the difference between the two has been decreasing over recent years.

Axis Mutual Fund's recent report indicated that India's share in the MSCI EM index has increased from 6.4 per cent in 2013 to its current 16.2 per cent. Concurrently, China's share has decreased from 42.5 per cent to 29.55 per cent during the same period.