Goodbye India Fund (IFN), Hello India Note (INP)

This morning I sold my shares of the India Fund (IFN) and purchased shares of the Barclay's India Index exchange traded note (INP).

I had bought shares of the India Fund, a closed-end fund run by Blackstone, early in 2005, largely because it seemed like the best way to track the Indian market (due to restrictions on foreign shareholders, there aren't any Index ETFs for India, and most Indian share ADRs are priced very differently from their domestic counterparts).

The shares were extraordinarily volatile, not only because the market itself has the tendency to move up and down rapidly, but because as a closed-end fund the shares usually trade at a widely variable premium or discount to the actual value of the shares (the value of the underlying stocks).

In many ways, the premium or discount (in recent years it's been a premium, though steep discounts have existed in the past) has been a good barometer for US investors feelings about the Indian market, which means the changes in that premium are likely to magnify dramatically the already wild swings of the underlying stocks.

I've lived with this because the fund seems to be more or less well managed, and has performed pretty well compared to their benchmarks -- but I didn't buy shares because I thought their stock picking would make them stand out from the pack of India mutual funds ... I bought shares because I wanted exposure to the Indian market.

And now there's a better way to get that exposure.

Barclay's, home of the ubiquitous iShare ETFs, has recently started a new product called iPath, a family of exchange-traded notes (ETNs). These in practice work much like ETFs, with daily trading volume on the NYSE and a close correlation to an underlying index. In reality, they're quite different -- they're not mutual funds as ETFs are, they are debt instruments that promise to return a value equal to the movement in the underlying index (including dividends, etc).

So while these products are new and this is the first equity-based one available from Barclays (the other three currently available are tied to commodity indexes), I'm buying in. I sold my India Fund shares at $44.08 (they had been purchased at $33.90) and bought INP shares at $51.32.

Here's how I see the difference between the IFN CEF and the INP ETN:

India Index Exchange Traded Note (INP):

• INP carries Barclays credit risk, since they're the ones promising the return.
• They do not carry any stock picking risk because they're mimicking the MSCI India Index, which tracks the biggest companies in India (though only 68 companies at this point, I'd compare this with the S&P 500 as a good representative of the country's market).
• INP will mimic the index nearly perfectly as it goes up or down, partly because Barclay's offers to redeem large blocks of shares at NAV.
• As a debt instrument, INP has a maturation date when the proceeds, whatever they are, will be automatically returned to you -- they're 30 year notes, so the date in this case is December 18, 2036. Of course, they can be bought or sold on the NYSE just like a stock, so there's no need to hold to "maturity" to get your money. There's no guaranteed return of principal at maturity.
• All return is capital return -- there are no dividends or distributions, the entire return is reflected in the share price when you sell.
• As essentially an unmanaged index product, the expense ratio is the lowest of any product that gives broad Indian market exposure: .89% right now (I'd like to see it a little lower since it's an index, but I'll take it).
  

The India Fund CEF (IFN):

• The India Fund carries stock picking risk, since they don't try to be an Index Fund (comparing the top ten holdings of IFN and of the Index shows you they have about five stocks in common).
• The India Fund will magnify the performance of the market, most likely (great performance of Indian stocks will likely bring in more investors, upping the premium ... a crash will likely send them to the exits, creating steep discounts).
• India Fund offers repurchase options to existing investors that you really must exercise if you don't want to lose money -- they're diluting your shares of the fund by selling existing investors shares at a discount to NAV, so if you don't buy in you're losing ground. While it's fun to exercise your rights and buy shares that immediately appreciate, it's no fun that you're essentially forced to do so (especially if you don't have the funds available).
• The India Fund has a dividend yield, so income investors are likely to be more interested in this one -- the dividend is highly variable, right now ETF Connect puts it at 7.5%.
  
• And finally, the IFN and one or two competitors have had this space essentially to themselves for years, which has led to some extremely high expense ratios. Right now the cost is not too bad at 1.5%, but that could change. And if the ETN product takes off and inspires competitors, the CEFs may suffer if they have to compete for investor dollars, possibly hurting current holders.

It might well be that the IFN will have higher returns -- but in my opinion, it also carries significantly more risk and comes at a higher cost. For what I want, index exposure to the broad Indian market, I think INP is a much stronger choice.

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