How To Compare The Wisdomtree India Earnings Index To The Msci India Index

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1 WisdomTree Research MARKET INSIGHTS [ October 2015 ] India Stands Out from Emerging Market Peers BY JEREMY SCHWARTZ, CFA, DIRECTOR OF RESEARCH, TRIPP ZIMMERMAN, CFA, ASSOCIATE DIRECTOR OF RESEARCH & GAURAV SINHA, ASSET ALLOCATION STRATEGIST Over the past year, broad emerging markets have continued to lag developed equity markets. China s continued slowdown and the uncertain impact of the Federal Reserve s 1 first rate hike in almost a decade are two main drivers of the relative underperformance. Another significant development and performance driver over the past year has been the collapse in oil prices. This has resulted in large divergences between various countries within emerging markets, mostly benefiting countries that are importers and harming the countries that rely on oil exports for growth. The table below compares the market performance of the 10 largest emerging market countries. FIGURE 1: EMERGING MARKET PERFORMANCE Country Equity Return in Local Currency Currency Return Against U.S. Dollar Equity Return in U.S. Dollars India 1.16% -8.72% -7.65% China -9.35% 0.00% -9.34% Taiwan -7.77% -8.13% % South Africa 4.11% % % MSCI Emerging Markets -9.53% % % Mexico -3.28% % % Indonesia % % % South Korea % % % Russia 15.09% % % Malaysia % % % Brazil % % % Sources: WisdomTree, Bloomberg, 8/31/14 8/31/15. Country list above is the top 10 country weights in the MSCI Emerging Markets Index as of 8/31/15. Country performance is represented by the respective MSCI country-specific Indexes. Currency return is computed as the difference between the respective countries Indexes calculated in local terms and dollar terms. Past performance is not indicative of future results. You cannot invest directly in an index. 1 Federal Reserve: The Federal Reserve System is the central banking system of the United States WISE (9473)

2 + India a Top-Performing Country: Over the period above, India was the top-performing country in U.S. dollar terms and a top-three performing country in local terms. India outperformed broad emerging markets, represented by the MSCI Emerging Markets Index, by 10.69% in local terms and 15.29% in U.S. dollar terms. India s currency was relatively resilient over the year compared to the U.S. dollar as a result of improvements in its current account 2 and falling inflation. + Volatility in China: Although the ending return for China over the period looks relatively decent, it doesn t shed light on the volatility 3 of a return path. At its top, the Chinese market was up almost 30% over the period, before falling approximately 30%, ending in negative territory as a result of compounding. China is the largest weight within the MSCI Emerging Markets Index, so it is also important to note that the currency return for China was 0% over the period because the above returns measure the performance of Chinese H-shares 4 only. These securities trade in Hong Kong dollars, which were flat against the U.S. dollar over the period. The Chinese yuan depreciated 3.69% against the dollar over the period. OPPORTUNITIES REMAIN IN INDIA At WisdomTree, we believe in the long-term potential of India s equity markets, especially given the tag team of prime minister Narendra Modi and Raghuram Rajan, governor of the Reserve Bank of India. These two have brought and can continue to bring investor-friendly pro-growth reforms and credible monetary policy, respectively. These initiatives, coupled with lower oil prices and improving profitability, provide an opportunity for India within emerging markets. The WisdomTree India Earnings Index (WTIND) is the broadest and most representative Indian index and the only index that focuses exclusively on profitable companies. Every year, at the end of August, WisdomTree screens the investable Indian equity market for the rebalance of its Index, which provides a plethora of information on the health and profitability of the market. In rupee terms, despite the relatively flat performance of Indian stock prices, the WTIND Earnings Stream 5 grew by 8.66%. At an aggregate level, this is one indication the Indian market became cheaper compared to its underlying fundamental 6 over this rebalance period. 2 Current account: The difference between a nation s total exports of goods, services and transfers, and its total imports of them. 3 Volatility: A measure of the dispersion of actual returns around a particular average level. 4 China H-shares: Chinese equities that are listed on the Hong Kong Stock Exchange. 5 Earnings Stream: Refers to the total net income for all constituents of WTIND. 6 Fundamentals: Attributes related to a company s actual operations and production as opposed to changes in share price WISE (9473)

3 FIGURE 2: WISDOMTREE INDIA EARNINGS INDEX EARNINGS STREAM [ Shown Annually as of Each Screening Date, in $ Billions ] 8/31/2008 8/31/2009 8/31/2010 8/31/2011 8/31/2012 8/31/2013 8/31/2014 8/31/2015 WidomTree India Earnings Index Earnings Stream (USD) $51 $45 $61 $81 $77 $67 $65 $65 % Annual Growth (USD terms) N/A % 35.56% 32.79% -4.95% % -1.99% -1.09% % Cumulative Growth (in USD, 8/31/2008 through specified date) N/A % 19.61% 58.82% 52.18% 30.59% 27.99% 26.60% % Annual Growth (in rupee terms) N/A -1.95% 30.69% 30.02% 14.50% 2.35% -9.73% 8.66% % Cumulative Growth (in rupee terms, 8/31/2008 through specified date) % Annual Change in India's Currency vs. U.S. dollar % Cumulative Change in India's Currency vs. U.S. dollar (8/31/2008 through specified date) N/A -1.95% 28.15% 66.61% 90.77% 95.25% 76.25% 91.52% N/A -10.0% 3.7% 2.1% -17.0% -15.5% 8.6% -9.0% N/A -10.0% -6.7% -4.7% -20.9% -33.1% -27.4% -33.9% Sources: WisdomTree, Standard & Poor s, as of 8/31/15. Past performance is not indicative of future results. You cannot invest directly in an index. THE FUNDAMENTAL DIFFERENCE The WisdomTree India Earnings Index seeks to provide exposure to the profitable core market of India s equities but to do so while maintaining sensitivity to valuation 7. To help achieve this, WisdomTree weights companies in the Index by the profits they generate, rather than their market cap 8, and rebalances back to profitability on an annual basis. WisdomTree s India Earnings Index rebalance process typically is driven by the following: + Earnings Growth: Companies that grow their profits see their weight increased. + Relative Performance: Underperformers typically see their weight increased. Outperformers often see their weight decreased. 7 Valuation: Refers to metrics that relate financial statistics for equities to their price levels to determine if certain attributes, such as earnings or dividends, are cheap or expensive. 8 Market capitalization: Share price x number of shares outstanding. Firms with the highest values receive the highest weights in approaches designed to weight firms by market cap WISE (9473)

4 FIGURE 3: QUANTIFYING THE WTIND ANNUAL REBALANCE Weight Change Percentage Change (INR) Percentage Change (USD) Median Earnings Growth Median Total Return Raised 30.3% 18.6% Lowered 7.3% -2.3% All 16.2% 5.8% Raised 10.2% 0.3% Lowered 12.0% 2.0% All 10.6% 0.7% Sources: WisdomTree, Standard & Poor s, 8/31/14 8/31/15. Past performance is not indicative of future results. You cannot invest directly in an index. + The companies that saw their weight raised at the rebalance had a median 9 earnings growth of 30.3%, which was greater than the 16.2% median earnings growth of all companies. Companies that saw their weight lowered at the rebalance had median earnings growth of just 7.3%, around 8.9% lower than all companies and 23.0% lower than companies that saw their weight raised. This disciplined rules-based rebalance process tends to shift weight to firms with lower price-to-earnings (P/E) ratios 10, as illustrated in the chart below. It compares the distribution of stocks by their P/E ratios in WTIND to that of the MSCI India Index, a widely followed market cap-weighted index that also measures the performance of India s equities. FIGURE 4: P/E RATIO DISTRIBUTION 60.0% 56.5% 50.0% WisdomTree India Earnings Index MSCI India 40.0% 36.4% Weight (%) 30.0% 26.2% 25.0% 20.0% 10.0% 18.2% 14.6% 11.6% 8.8% 0.0% Quartile 1 (PE below 18.1x) Quartile 2 (PE From 18.1x to 25.7x) Quartile 3 (PE From 25.7x to 45.7x) 2.6% Quartile 4 (PE above 45.7x) 0.0% Negative Earnings Sources: WisdomTree, Bloomberg, as of 8/31/15, based on WTIND Index screening. The P/E quartiles are determined using the MSCI India Index. You cannot invest directly in an index. Past performance is not indicative of future results. Subject to change. 9 Median: The value within a dataset at which 50% of all observations occur above and 50% occur below. 10 Price-to-earnings (P/E) ratio: Share price divided by earnings per share. Lower numbers indicate an ability to access greater amounts of earnings per dollar invested WISE (9473)

5 + More Weight to Lower-Priced Stocks: The WisdomTree India Earnings Index has more than 50% of its weight in the lowestpriced quartile, which is significantly more than the MSCI India index. There is a natural tendency of earnings-weighted approaches to reduce weight to stocks whose prices have appreciated at a faster rate than their earnings, and concurrently to increase weight to stocks that have fallen in price despite exhibiting positive earnings growth. + Less Weight to Higher-Priced Stocks: On the other hand, WisdomTree s approach has less than 3% of its weight going to the highest-priced quartile. The MSCI India Index had more than 20% of its weight in the most expensive quartile and stocks with negative earnings. + Negative Earnings and Speculative Stocks: Although profitability may fluctuate throughout the year, at each annual rebalance WisdomTree requires companies to be profitable before inclusion. This requirement keeps the weight to firms that we believe tend to be more speculative and of lower quality at zero. The MSCI India Index does not share this requirement. BROAD EXPOSURE REMAINS A PRIORITY WisdomTree strives to encapsulate a broad measure of the Indian equity markets, as opposed to a large-cap 11 subset that is often referred to when quoting performance of the Indian equity markets. As of the most recent rebalance, the WisdomTree India Earnings Index had 300 securities that spanned the large-, mid- and small-cap segments. The MSCI India Index had 70 companies that are primarily large cap and mid-cap. We think the omission of the small-cap segments is a significant difference between the WisdomTree approach and a market capitalization-weighting methodology. FIGURE 5: SIZE CAPITALIZATION EXPOSURE Total Index Large Cap (>$10 billion) Mid Cap ($2 billion to $10 billion) Small Cap (<$2 billion) WTIND MSCI India WTIND MSCI India WTIND MSCI India WTIND MSCI India Weight 100.0% 100.0% 62.0% 73.8% 23.9% 26.1% 14.1% 0.1% Market Capitalization ($B) $1,143 $836.7 $644.6 $611.4 $349.0 $224.4 $149.4 $0.9 Number of Firms P/E Ratio 12.5x 20.3x 14.0x 18.1x 11.7x 30.3x 9.3x N/A Sources: WisdomTree, Bloomberg, as of 8/31/15, based on WTIND screening. You cannot invest directly in an index. Past performance is not indicative of future results. Subject to change. + Small-Cap Exposure Increases Diversification: Through 195 holdings, WTIND had more than 14% exposure to the small-cap segment of the Indian market, compared to only one security with less than 0.1% weight for the MSCI India Index. It is also interesting to note that the P/E ratio for the small-cap segment of WTIND is around 9x earnings, which is more than 25% lower and 54% lower than the large-cap segment of WTIND and MSCI India, respectively. Typically, small-cap stocks might be expected to trade at higher valuations than large-cap stocks as a result of the higher expected growth potential. 11 Size capitalization: A measure by which a company s size is classified. Large caps are usually classified as companies that have a market cap over $10 billion. Mid-caps range from $2 billion to $10 billion. Small caps are typically new or relatively young companies and have a market cap between $200 million and $2 billion WISE (9473)

6 WISDOMTREE INDIA EARNINGS INDEX EXPOSURES Below we outline how the annual rebalance impacted sector changes for the WisdomTree India Earnings Index. We will compare the sector composition before the annual screening to the sector composition after the rebalance. Additionally, we will compare the underlying sector performance to the broad Index to look at the performance of sectors that saw their weights increase or decrease. It is the interaction of earnings growth and price performance that provides the basis for determining which sectors tend to see increases or decreases in weight at the annual WisdomTree Index rebalance. FIGURE 6: WISDOMTREE INDIA EARNINGS INDEX SECTOR CHANGES Old Weight 1 Sector Performance 2 New Weight 3 Change in Weight Performance of Sector Relative to WTIND Materials 5.6% -41.4% 5.8% 0.2% -28.7% Underperforming Sectors Energy 16.1% -25.8% 17.6% 1.5% -13.1% Utilities 5.1% -24.7% 4.4% -0.7% -12.0% Consumer Discretionary 8.3% -22.3% 9.3% 1.0% -9.6% Telecommunication Services 1.8% -18.6% 2.9% 1.1% -5.9% Financials 26.6% -7.0% 25.3% -1.3% 5.7% Outperforming Sectors Industrials 5.5% -3.0% 5.3% -0.2% 9.7% Consumer Staples 4.8% -1.0% 4.6% -0.2% 11.7% Information Technology 20.1% 0.3% 18.9% -1.2% 13.0% Health Care 5.9% 23.5% 5.9% -0.1% 36.2% Old Weight 1 Average Sector Performance 2 New Weight 3 Change in Weight Average of Sector Performance Relative to WTIND Sectors That Underperformed 37.0% -26.6% 40.0% 3.1% -13.9% Sectors That Outperformed 63.0% 2.6% 60.0% -3.1% 15.3% Sources: WisdomTree, Bloomberg, as of 8/31/15 1 Old weight is WTIND index weight as of 8/31/15, before the rebalance. 2 Sector performance is from last year s rebalance to 8/31/15. 3 New weight is the anticipated sector weights for WTIND after rebalance based on 8/31/15 annual screening. Subject to change. + Adding Weight to Underperformers and Subtracting Weight from Outperformers: WTIND added the most weight to the Energy, Consumer Discretionary and Telecommunication sectors, all of which underperformed the broad Index over the period. Each of these sectors had median earnings growth that was higher than median price growth, ultimately improving the relationship between earnings and prices. On the other hand, WTIND subtracted the most weight from Financials and Information Technology, two sectors that outperformed the broad Index over the period. This is another example of how the annual rebalance process acts as a forced discipline to sell high and buy low, based on underlying fundamentals WISE (9473)

7 FINANCIALS REMAIN IN FOCUS A sector that surely stands out for India is Financials, currently accounting for about 6% of its approximate $2 trillion gross domestic product (GDP). We think this sector has special underpinning in India s growth potential, and growth will be led by the commercial bank and insurance industries. Commercial bank assets are expected to grow from $1.4 trillion (August 2015) to an enormous $28.5 trillion by FY India s life insurance industry is the biggest in the world with about 360 million policies, and this is expected to increase at a compounded annual growth rate of 12% to 15% over the next five years. 12 A fast-growing economy, rising income levels and improving life expectancy rates are some factors that will boost earnings in this area. Thus, it is no surprise that Financials has been a key sector in recent budget presentations and in several other reforms launched by the Modi government. The Finance Ministry and Reserve Bank of India (RBI) have taken a host of measures to liberalize, regulate and reform the industry. Primary steps include the following: + Strengthen & Increase Access for Investors: Foreign institutional investor (FII) 13 and foreign direct investment (FDI) 14 limits merged into a composite sectoral cap of foreign investment. New composite sectorial limit for private banks is at 74%. This is encouraging as FII is relatively easier to invest and liquidate. Now unused capacity from FDI could be filled up by FII investments, giving foreign investors the opportunity to buy equities in India. + Steps to Expand Volumes & Bolster Earnings: Through aggressive credit targets in various subsectors such as agriculture, retail, housing and mortgage lending. Reform measures are targeted to encourage credit and debit transactions, ultimately helping grow earnings. + Reduction in Corporate Taxes from 30% to 25% 15 THE CASE FOR INDIA As we stated above, we believe India s potential is being fueled by the investor-friendly, pro-growth reforms of Prime Minister Modi and the monetary policy credibility of central bank Governor Rajan. Reforms have been at the very core of the current Indian government, and with an eye on a revival of the manufacturing sector, one of the first projects Modi kick-started was Make in India. The goal under this project is to double India s annual exports by 2020 and increase its share of exports to the world from 2% to 3.5%. 16 This will be accomplished primarily by increasing tax incentives and eliminating bureaucratic red tape, both seen as positive for equities. 12 Source: Government of India, Indian Brand Equity Foundation. 13 Foreign institutional investor: An investor or investment fund that is from or registered in a country outside of the one in which it is currently investing. 14 Foreign direct investment (FDI): An investment made by a company or entity based in one country into a company or entity based in another country. 15 Source: Government of India, Union Budget Source: Government of India WISE (9473)

8 On the monetary side, the decline in oil prices has been a windfall for oil importers like India in many ways, but one main advantage is that it helped cool inflation 17. As a result, the Reserve Bank of India cut repurchase (repo) rates 18 for the fourth time in a row on September 29, 2015, and we believe it has more room to cut. Typically markets react positively when central bankers cut interest rates, and we expect these rate cuts to provide support for equities. It is important to note that under the excellent leadership of Rajan, RBI established itself as an inflation-fighting central bank and has been regularly intervening in FX 19 markets to stabilize any temporary volatility. We are optimistic Rajan will be able to successfully guide India through this uncertain market environment and correctly signal to the market what it can expect from the central bank. WisdomTree believes that weighting by market capitalization, which does not weight, consider or rebalance back to any measure of economic importance of the underlying constituents, may not be the best approach. Instead, we believe a disciplined strategy of anchoring allocations back to a measure of relative value, based on fundamentals such as earnings, can add value over time. The India Earnings Index rebalance has refreshed its constituents and reweighted securities to emphasize weights for those companies that have grown their earnings compared to their prices over the prior 12 months. Despite the volatility of emerging market equities, for investors who share our belief in India s long-term growth prospects, we think this recent rebalance could be an entry point. 17 Inflation: Characterized by rising price levels. 18 Repo rates: The rate at which the central bank of a country lends money to commercial banks in the event of any shortfall of funds. 19 Foreign exchange (forex, FX): The exchange of one currency for another, or the conversion of one currency into another currency WISE (9473)

9 Unless otherwise stated, data source is WisdomTree. Investors should carefully consider the investment objectives, risks, charges and expenses of the Funds before investing. To obtain a prospectus containing this and other important information, please call WISE (9473) or visit wisdomtree. com. Investors should read the prospectus carefully before investing. There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Some Funds focus their investments in India, thereby increasing the impact of events and developments associated with the region, which can adversely affect performance. Investments in emerging, offshore or frontier markets such as India are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments. As the Funds have a high concentration in some sectors, they can be adversely affected by changes in those sectors. Due to the investment strategy of certain Funds, they may make higher capital gain distributions than other ETFs. Please read the Funds prospectus for specific details regarding the Funds risk profile The Global Industry Classification Standard ( GICS ) was developed by and is the exclusive property and a service mark of MSCI Inc. ( MSCI ) and Standard & Poor s ( S&P ), a division of The McGraw-Hill Companies, Inc., and is licensed for use by WisdomTree Investments, Inc. Neither MSCI, S&P nor any other party involved in making or compiling the GICS or any GICS classifications makes any express or implied warranties or representations with respect to such standard or classification (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability and fitness for a particular purpose with respect to any such standard or classification. Without limiting any of the foregoing, in no event shall MSCI, S&P, any of their affiliates or any third party involved in making or compiling the GICS or any GICS classifications have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. WisdomTree India Earnings Index: A fundamentally weighted Index that measures the performance of companies incorporated and traded in India that are profitable and that are eligible to be purchased by foreign investors. Companies are weighted in the Index based on their earnings in their fiscal year prior to the Index measurement date, adjusted for a factor that takes into account shares available to foreign investors. MSCI Emerging Markets Index: A broad market cap-weighted Index showing the performance of equities across 23 emerging market countries defined as emerging markets by MSCI. MSCI India Index: A market capitalization-weighted index designed to measure the performance of the large- and mid-cap segments of the Indian equity market. MSCI China Index: A free float-adjusted market capitalization-weighted equity index designed to measure the performance of the Chinese equity market. MSCI Taiwan Index: A free float-adjusted market capitalization-weighted equity index designed to measure the performance of Taiwan s equity market. MSCI South Africa Index: A market capitalization-weighted index designed to measure the performance of the South African equity market. MSCI Mexico Index: A free float-adjusted market capitalization-weighted equity index designed to measure the performance of the Mexican equity market. MSCI Indonesia Index: A free float-adjusted market capitalization-weighted designed to measure the performance of the Indonesian equity market. MSCI South Korea Index: A free float-adjusted market capitalizationweighted equity index designed to measure the performance of the South Korean equity market. MSCI Russia Index: A free float-adjusted market capitalizationweighted equity index designed to measure the performance of the Russian equity market. MSCI Malaysia Index: A free float-adjusted market capitalizationweighted equity index designed to measure the performance of Malaysia s equity market. MSCI Brazil Index: A free float-adjusted market capitalization-weighted equity index designed to measure the performance of the Brazilian equity market. WisdomTree Funds are distributed by Foreside Fund Services, LLC. Jeremy Schwartz & Tripp Zimmerman and Gaurav Sinha are registered representatives of Foreside Fund Services, LLC WisdomTree Investments, Inc. WisdomTree is a registered mark of WisdomTree Investments, Inc. WTGM WISE (9473)