India to see $3.6-bn inflow from US federal pension fund index switch

India to see $3.6-bn inflow from US federal pension fund index switch

The decision by the U.S. Federal Retirement Thrift Investment Board (FRTIB) to switch its benchmark index for international funds is expected to have significant implications for India, positioning the country to receive a substantial inflow of $3,595 million. This move is part of a broader effort by the FRTIB to shift around $28 billion (approximately Rs 2.3 lakh crore) across global equities.

India stands out among emerging markets as one of the major beneficiaries of this index switch, marking a significant development for the country’s financial markets. Analysts are optimistic about the positive impact of these inflows, emphasizing India’s potential to attract a considerable share of the funds being reallocated by the FRTIB.

India to see $3.6-bn inflow from US federal pension fund index switch

What makes this particularly noteworthy is that it represents the first time India will be receiving inflows from the FRTIB, as the country was not part of the old index but has been included in the new one. This inclusion is indicative of the growing recognition of India’s economic potential and attractiveness as an investment destination, especially within the context of global equity benchmarks.

The anticipated inflow of funds is expected to contribute to India’s economic development and further strengthen its position in the global investment landscape. Additionally, it underscores the confidence of international investors in India’s economic prospects and the potential for returns in the Indian equity market. As a result, this development could have positive ripple effects on the country’s financial markets and overall economic growth, marking a significant milestone in India’s participation in global investment portfolios.

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The decision by the Federal Retirement Thrift Investment Board (FRTIB) to switch its benchmark for the international stock investment fund is a significant move that will impact the composition of the fund and result in considerable market churn. The FRTIB has chosen to transition from the EAFE index to the MSCI ACWI IMI ex-USA ex-China ex-Hong Kong index.

The EAFE index traditionally comprises 21 developed markets across Europe, Australia, Asia, and the Far East. However, the new MSCI ACWI IMI ex-USA ex-China ex-Hong Kong index represents a departure from the strictly developed market focus. This new index includes a broader mix of both developed markets (DMs) and emerging markets (EMs), excluding China and Hong Kong. This adjustment reflects a more diversified approach, potentially capturing a wider range of investment opportunities across different market segments.

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Given that approximately $68 billion is invested in the I-Fund, which passively tracks the benchmark index, the benchmark switch will trigger significant changes in the constituent stocks. The churn among these stocks is expected to occur in 2024, as the transition is implemented. Investors and fund managers will need to adapt their strategies to align with the revised index, potentially leading to shifts in asset allocations and portfolio structures.

This move by the FRTIB not only signifies a shift in its investment strategy but also reflects a broader trend in investment markets towards incorporating a more comprehensive and diversified set of opportunities. The inclusion of emerging markets in the new index suggests a recognition of the potential growth and investment prospects in these markets.

As with any significant benchmark switch, it will be essential for investors to monitor these changes closely and consider the potential implications for their portfolios, as adjustments to the fund’s composition can have varying impacts on risk and return profiles.

The planned benchmark switch, to be executed in 16 tranches over a four-month period with each tranche taking place every five days, is expected to have substantial implications for capital flows across developed and emerging markets. The one-way trade of approximately $28 billion is anticipated to result in outflows from developed markets (DMs) and inflows into emerging markets (EMs).

In the context of the iShares Emerging Markets ETF, several countries, including India, Taiwan, Korea, Brazil, Saudi Arabia, South Africa, and Mexico, are projected to be the primary beneficiaries of these inflows. An analysis conducted by Brian Freitas of Periscope Analytics, as reported on Smartkarma, suggests that these countries are likely to experience significant gains within the ETF.

Conversely, certain developed markets are expected to witness the largest outflows. Japan, the UK, France, Switzerland, Germany, and Hong Kong are among the countries projected to see substantial capital outflows. This shift in capital allocation reflects the changing dynamics brought about by the benchmark switch, as the investment strategy pivots towards a more diversified mix that includes emerging markets.

Such adjustments in capital flows have the potential to impact the performance of equity markets in the affected countries. Investors will need to carefully assess the implications for their portfolios and consider adjusting their investment strategies accordingly. Additionally, the phased approach to the benchmark switch allows for a systematic and controlled transition, potentially mitigating the risk of market disruptions associated with abrupt changes.

Overall, this benchmark switch is a notable event in the global investment landscape, and its effects will be closely monitored by investors, market participants, and analysts as it unfolds over the planned four-month period.

The impact of the benchmark switch is poised to be selective, sparing the influence on U.S. and Chinese equities as they are not part of either the old or new index. However, Hong Kong is anticipated to be significantly affected as it is included in the old index but not the new one.

The data indicates that the Federal Retirement Thrift Investment Board (FRTIB) will need to sell approximately $1.5 billion worth of Hong Kong stocks. This divestment could result in an increase in the floating stock of these companies by 48-50 basis points (bps), potentially exerting downward pressure on stock prices during the implementation phase, according to analysis by Brian Freitas.

Conversely, the countries that stand out as potential losers in this transition include Japan, the UK, and France. The downgrade in their weightage in the benchmark is estimated to lead to outflows of up to $3,904 million, as per Freitas’ analysis. This reduction in exposure could result in selling pressure on stocks from these countries, impacting their equity markets.

The phased approach to the benchmark switch, executed over a four-month period in 16 tranches, provides a structured framework for implementation. However, the selective impact on certain regions and countries underscores the complexity of managing large-scale transitions in global investment portfolios. Investors and market participants will closely monitor these developments, adjusting their strategies as needed to navigate the changing landscape of international equity investments.

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