Should you invest Motilal Oswal MSCI EAFE Top 100 Select Index Fund?

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Motilal Oswal AMC has launched the Motilal Oswal MSCI EAFE Top 100 Select Index Fund (MOST EAFE). This is the latest in the spate of NFOs in the last one year promising geographic diversification opportunity for investors in India. Compared to the international-focussed NFOs over the last year which were mostly fund of funds, MOST EAFE is an index fund. This, however, as such does not make a significant difference to investors. The fund gives debt taxation with indexation benefits after 3 years.

The fund

MOST EAFE will invest in securities of the MSCI EAFE Top 100 Select Index (MSCI EAFE 100) and reflect its performance subject to tracking error. The MSCI EAFE 100 is a subset of the MSCI EAFE Index, one of the largest non-US ETF themes globally designed to represent the performance of 21 developed markets across Europe, Australasia and the Far East. Within this, MSCI EAFE is designed to tap investment opportunities in the top 10 out of the 21 countries and the 100 largest companies from the investment universe of these top 10 countries.

Stock weights are based on market capitalisation (adjusted for free float and foreign investment limits), and country weight is capped at 40 per cent. Rebalancing is on a quarterly basis. Based on historical data and market cap, MSCI EAFE will cover 48-49 per cent of the parent index.

Index characteristics

Currently, the top 10 EAFE countries and their approximate weights in the index are Japan (19 per cent) the UK (20.4), France (15.2), Switzerland (14.7), Germany (11.2), Australia (7.4), the Netherlands (6.8), Hong Kong (2.7), Spain (2.1) and Sweden (0.5). In terms of sectors, financials (18 per cent), healthcare (16) and consumer discretionary (15) represent nearly 50 per cent of the index.

The top 5 stocks in the index are consumer staples giant Nestle (4.4 per cent), semiconductor company ASML Holding (4), healthcare company Roche (3.3), fashion leader LVMH Moët Hennessy/Louis Vuitton (2.5) and auto majorToyota Motor.

Underwhelming performance

With regard to performance, the index returns as such have been underwhelming across time periods. In the last 10 years it has given CAGR returns (INR) of 12.2 per cent versus the Nifty 500’s 15.5 per cent (all TRI), and for the last one year it returned 26.8 per cent versus Nifty 500’s 62.9 per cent. It has also similarly significantly underperformed the US S&P 500 across these time periods (see table).

Further, the returns for MSCI EAFE 100 would be even lower if not for the INR currency depreciation benefits versus the respective currencies of the countries in the index. While its annualised volatility for 5,3 and 1-year period is lower than that of Nifty 500, the difference is not significant to compensate for the lower returns.

In terms of valuation, as of September 30, the index was trading at a PE ratio of 18 times versus 10-year average close to 16, P/B of 2.1 times versus 10-year average of 1.7. Dividend yield was at 2.7 per cent versus 10-year average of 3.5 per cent.

No compelling case

As per the NFO presentation the need for Indian investors to diversify into international markets is definitely strong given the opportunity it offers and also due to the crowding out of scarce opportunities in some pockets domestically that stretches valuations. However, diversification for the sake of diversification may result in sub-optimal returns for investors.

International diversification objective must be complemented by a sectoral (information technology/new-age companies in the US, REITs, renewables), or cyclical (commodity-heavy countries), or geographic (emerging/frontier economies) themes. As such, the MSCI EAFE 100 does not offer any strong theme. It may be more relevant for developed market investors (institutions and individuals) who may already be heavily invested in the US and hence may need to diversify into non-US developed markets to hedge their risks. However, this is not the case for Indian investors who are still significantly underinvested into the US markets or the mega tech/ growth/ innovation themes globally. The first choice of diversification must be into thematic offerings and the US markets.

A deep value buy opportunity that may compensate for lack of a strong theme is also absent in the case of the index. While its valuation is cheaper relative to Indian or US benchmark indices, it is higher than historical levels.

The index might fall relatively less in a market crash, but the reason to buy into equities is not because it will fall less but because it must offer strong growth opportunities over risk-free options.

There may be some case to buy into specific geographies within the EAFE top 10 countries like the UK whose benchmark index FTSE 100 is still trading below pre-Covid levels and appears to offer good absolute value/growth prospects. However, its weightage in the MSCI EAFE 100 is only at 20 per cent and hence a better way would be any ETF or FoF that directly offers options to buy into such undervalued geographies (currently none).