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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Lightening up on the India Fund (IFN)

I started to lighten up on my holdings in the India Fund (IFN) about a month ago, and today I sold off the remainder of my holdings (though I'll continue to own some ... more on that in a moment). I made my earlier sales at $47 in early July, and sold the balance at $40.75 today.

That makes for a nice profit in a bit over a year -- I originally bought in early July last year at $30.15.

So why did I sell? Well, there are a couple reasons.

I do still think India is a solid investing market, and I expect it will make some fortunes in the years to come ... that's why I'll still come out of this with a small IFN position. But after a huge run up, I'm quite cautious about the near term performance of the Indian stock market, even after their big selloff in the last month or two.

But primarily I sold because of the structure of the fund itself. If it were an index fund, none of which are available for India at the moment, I might have continued to hold. But the India Fund is a closed end fund, which means it's essentially a mutual fund with a fixed number of shares that can be traded on the market at either a discount or premium to its actual asset value.

And the India Fund now trades at a pretty dramatic premium. When I bought shares about a year ago, the shares were trading at a premium to the underlying value of the stocks they held of under 5% -- and that seemed a reasonable premium to pay for me.

But today, the premium has gotten entirely out of whack and stands, as of Friday, at 19%. That means of the 40% or so in gains I've gotten from this stock, more than a third of the gains have been from the increase in the premium. This is the largest the premium has ever been, the shares have, since inception, typically traded at a very small discount or premium in the range of 3-6%, and the only time it's gotten this out of whack was back during the late 90s stock market boom when it traded at a 10%+ discount.

The premium can be loosely interpreted as a measure of US retail investor enthusiasm for the Indian market, since it's a very difficult market to invest in for small outsiders (except for a few big ADRs like Tata and Infosys), and based on that I think holding a big chunk of this fund is taking a big near term risk. Even if the Indian market continues to perform relatively well, if it just stays more or less stagnant and investor enthusiasm wanes we could possibly see a 15-30% drop that has very little to do with the earnings or performance of the companies in the fund.

Add to that the fact that Blackstone charges a pretty high management fee for this fund, something in the range of 4%, and I think I'm taking too much of a chance in maintaining a full position.

But I said that I was going to keep some anyway -- how? Well, IFN is in the midst of a rights offering for current shareholders, which allows us to purchase shares at a 5% discount to the net asset value (making the discount compared to the actual market value very large indeed). I've sold all my holdings but am exercising my rights, which means I'll essentially end up with about a third of my original holdings at a new cost basis that is only slightly above the price I originally paid, and that is significantly lower than today's market price, while locking in some very good gains for my original purchase.

Exercising my rights offering was a no-brainer -- it will likely be possible to make a profit just by exercising the rights and then selling immediately, assuming the shares don't move too quickly in the next few weeks to close the premium gap (the price will be determined based on the NAV this Friday). But I'll hold, at least for now -- I'm willing to hold these new shares as a flier on the Indian economy, but I have great reservations about the fund's overhead and effective leverage (the premium) and would be delighted to see that market open up a big more to foreign investment so that a nice low cost, high correlation index fund could be opened.

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Investing with the World Cup?

I've been twiddling my thumbs for several days while I look for somewhere to deploy my cash and get fully invested during this downturn. I've been mostly looking at energy and materials stocks since they've fallen farther and faster than many others, and for reasons that I don't believe are sustainable.

But I haven't been willing to pull the trigger yet -- Pride International still looks incredibly cheap to me but I fear the scandal and wonder if we might see a further decline if and when more details emerge ... SeaDrill is now looking like a bargain, something it has not been for about six months, but I already have a large underwater SDRL.OL position and I'm a little cautious. And I just bought Chesapeake Preferred for some safer natural gas exposure and would rather wait for more downwared movement before adding to that position. I'm sure there are other great candidates out there as well, I'm keeping my eyes open.

But in the meantime I've been watching and listening to the World Cup games and wondering, in the back of my mind, whether there are any investment lessons or ideas in the world's greatest sporting event. Probably not, but I'll humor myself. Here's what came to mind.

If there are any lessons to take away for me, the significant one is probably "be patient" -- successful soccer teams can't press all their men forward at all times, they have to wait for good opportunities and then jump in with both feet to press the attack. Patience has been hard to learn as US team follower, I was shocked at how terribly they performed in their first game, but the patient fan waited to judge ... and they dramatically outplayed Italy in their second game. Now my lesson is to be patient while I chew my nails awaiting the Ghana game on Thursday.

But might there be some ideas for investing here? In the US, this is still a minor sport -- but for the first time all the games are available nationwide on both TV and radio. I well remember watching previous Cups on Univision because many of the games weren't televised in English, and, frankly, my college Spanish didn't do me much good on the radio broadcasts (though it's still thrilling to hear Andres Cantor scream "GOOOOOOOLLLLLLLLLLLLLLLL!" -- even if you cant' tell which team or player scored). Hopefully soccer is catching up with hockey here at home, though I'm not holding my breath, and I've been thrilled to be able to catch almost every game.

But that probably doesn't make much money for everyone. Sure, I imagine a few soccer diehards signed up for XM radio (XMSR) in order to get the broadcasts of every game ... but XM has already warned that they'll be missing their customer acquisition targets for this year, and I don't imagine this will make the difference.

And Disney (DIS), owner of the US World Cup broadcasters ABC and ESPN, is doubtless making more money on showing a US soccer game on saturday afternoon than they would on MacGyver reruns, and hopefully ESPN gets better ratings for the other games than they do for poker ... but it's probably not going to move the needle. I actually like Disney partly because of the dominance of the ESPN franchise, but I wouldn't buy at these post-Pixar prices and didn't pay enough attention to buy a year ago when it was a certifiable bargain.

So what about other countries? I have focused a lot on international investing of late -- India (IFN) is probably the weakest major nation in the world when it comes to sports, and Norway (home to my SeaDrill investment) isn't setting anything on fire unless it's the Winter Olympics, but a lot of my other holdings are in cup-crazy lands.

Korea is still riding high from their strong performance in the last Cup, and they've done well so far this year. Thanks in large part to the utter disappearance of the French team, they've got a chance to make it to the next round. If we read into this, is Korea a better investment than France? I think you don't need to know what an offsides trap is to know that's pretty likely -- Korea is low priced explosive growth, France is a few dominant international companies and a domestic economy totally crippled by tradition. I actually own a Swiss company as well, UBS, but I'd like to see the Koreans beat the Swiss and outpoint France to move forward.

Cemex (CX) is one of the materials companies I've been keeping a very close eye one, and it's one of the largest companies in the Mexican market. Will Mexico's possible advancement make any difference to this major international cement company? Not likely -- infrastructure development around the world, continued residential and commercial construction in the US and elsewhere ... that's what moves CX's needle. Oil prices and the US consumer have more of an impact on the Mexican economy than does soccer fandom, I expect.

On the other hand, if Angola manages to really clobber Iran, and Mexico falls badly to Portugal, group favorite Mexico would be sent home -- so would a huge success in the next round or a failure to advance have more of an impact on beer consumption in Mexico? Not sure whether Mexicans drink more in celebration or in wallowing, but I still like FEMSA, brewer of Dos Equis and Tecate and remain interested if I can get a good price on those shares.

Brazil, home of one of my other large positions, GOL Linhas Aereas Inteligentes, might shut down if they win the Cup yet again -- but even in what might be the world's most soccer-crazed nation I don't expect it will cause travel behavior to change. It might get very interesting if 5,000 Brazilian Cup fans get stranded by the possible cancellation of Varig flights to Europe, but I think the largest impact might be that a nation distracted by Ronaldo's enlarged tummy might have not payed enough attention to the final wrapup of the bankruptcy proceedings, which have now led to purchase by an employee and investor group. I expect GOL's executives are cheering just as loudly for this purchase as they are for Ronaldinho, Varig was incapable of managing itself efficiently before because the airline was run largely for the benefit of the employees -- how much worse might that get now that the airline will be answerable directly to the employee and retiree unions?

I was actually a little surprised when I didn't hear Cramer running out his standard shtick for any large sporting event. During the Super Bowl and during the NCAA Final Four, he yelled for investment in companies that profit from online streaming video and big screen TVs -- I may have missed it, but I didn't hear that this month, though certainly plenty of folks around the world are catching highlights from their desks and buying new big screen TVs to watch their heroes compete. I expect that's because the market has been in a precipitous downturn this time around and there has been recent fear of an inventory glut from Corning and AU Optronics on large screen components (even though Best Buy and Circuit City recently announced that they sold many more of these sets than anyone expected -- too bad none of those sales were to me).

But I actually do still like Akamai very much -- Cramer has been pooh-poohing it in the short term, probably rightly as most stocks that have more than doubled in the past year are seeing a lot of selling pressure, but I imagine Akamai's getting a fair amount of business from their clients around the world as they manage streaming Cup video clips and, perhaps in some countries, full games.

So probably no lessons or real investment knowledge to be gleaned from the World Cup -- but at least a few interesting things to think over as we wait for the next great game.

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Annual Checkup -- EWY and IFN

These two odd birds in my portfolio are of a feather, so I'll consider them together. These are not individual companies, but EWY is the South Korean index ETF and IFN is the India Fund, a closed-end mutual fund of Indian stocks. (EWY or IFN for free RT quote). While I have positions in some mutual funds that have strong foreign exposure in the Third Avenue International Value Fund (TAVIX) and the Dodge and Cox Foreign Stock Fund (DODFX), I think international exposure in general is very important and I thought it made sense to commit a bit extra to these two countries. India and South Korean markets have been on a tear this year, so my positions are up by just about 30% each -- a little more in Korea, a little less in India (note that the big slip in IFN at the end of the year was due to a large dividend). I still think these two countries are in the sweet spot, but I believe in them for different reasons. The Korean fund I like primarily because I think Korea is still trading at an emerging market valuation even though the country's major corporations have really reached first world status. EWY is a great way for me to get exposure to Samsung, Hyundai, Posco, and the various big Korean banks that should have great success -- especially as their Chinese neighbors continue to expand vigorously and the Japanese economy rebounds. India is not as company specific -- I don't even know of many individual Indian companies aside from Infosys, but the economy is growing nearly as fast as China's but the population and the economy in India are much more reliable and stable, and as the world's largest democracy with a great education system I think their future is bright.

Being invested in these two bookends to China makes one consider why I haven't included a Chinese fund here. Though I have invested in some Chinese companies, I'm not so confident about the Middle Kingdom's ability to pull off this kind of growth without some serious upset, either political or economic, and I'm not so comfortable with their huge government ownership when the government's needs can conflict with those of individual investors. I think it's important to look for good Chinese companies, but I'm not as comfortable with "buying the country" in an ETF or broadly diversified CEF. At least, not now. I see no reason to adjust my foreign exposure this year, I'll be holding on to my IFN and EWY shares but don't plan to add any more at this point.

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Changes to portfolio

I haven't gotten around to writing up these two companies, but I just sold them ... will explain more in detail later.

Sold CNET on June 30, 2005 for $11.98

I had bought CNET at 9.20 on March 30 and 10.14 on April 28. I sold all my holdings in this one at 11.98 on June 30.
Why did I sell? Because I had been becoming uncertain about why I had bought. I'm a CNET user, but I bought it after reading up on some articles in Motley Fool and elsewhere and convincing myself that they had uniquely valuable web real estate (download.com, cnet.com, mysimon, etc.) which pulled in unusually high advertising revenues per user. This was and is true, but as I continued researching it after buying my two positions, I became more and more concerned about competition from Google and Yahoo (and others, I'm sure). CNET was a very early mover at supplying premium online content supported by advertising, but the more I read the less certain I was that they would be able to maintain their competitive advantage, and the premium price of the shares was making me a little nervous. I still think that the online delivery of premium (and bandwidth-intensive) content is a good business, but I no longer want to focus my money on CNET as an investment in this area. I'm keeping my investment in Akamai (AKAM) and would like to add to it, I see them as a better investment in the future of rich commercial internet content, since they enable reliable and fast delivery of content for any provider who wants to pay for that insurance (and their acquisition of their major competitor, Speedera, means they've got more growth potential and pricing power going forward).

When buyout rumors surfaced in the NY Post and quickly spread online last week, the stock shot up 10%. This was a good opportunity for me to sell out of a position that I had lost faith in and that I thought was becoming overvalued, so I sold. It might have been a mistake to sell, it's certainly possible that the analysts foreseeing a $14 takeover price for CNET by one of the big boys will be correct. I'll take my small profit for a couple months work and cheer it on from the sidelines.

Sold AAUK on July 7, 2005 for 23.44

I had bought Anglo American UK on January 7 for 22.50, so this is pretty much a wash. AAUK had held the position in my portfolio of being a commodity (precious metals/ore/diamonds/coal) play, and I decided this summer that this wasn't necessarily something I needed to have exposure to in an individual stock. I like a couple things about AAUK, including the fact that I still think they're generally undervalued because they don't get enough credit for their interest in DeBeers, but there are two basic things that made me sell: 1, I didn't think I wanted to buy a company just as a hedge without really understanding their business well or their prospects, which is what I had done when I bought AAUK; and 2, I had other areas I wanted to invest in and this was the only other holding (besides CNET) that was on my "think about selling" list.

Bought IFN on July 7, 2005 for $30.15
Bought EWY on July 7, 2005 for $31.90

These are two of a feather as far as my strategy goes, but are very different animals. IFN is the closed-end actively managed India Fund, while EWY is an ETF for the South Korean Index. I bought both to expand my international diversification in the two countries that I see as growing parts of the world economy with relatively low risk -- India because political risk is limited as their increasingly business-friendly government is stable and democratic, and South Korea because market risk is somewhat limited by the fact that South Korea is the bargain basement of the world's emerging markets, with growing and dominant companies that I believe are extremely undervalued. Will provide more of my thoughts on these purchases as I have time.

Technorati tags: anglo american, aauk, Akamai, AKAM, cnet, india, south korea

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