INDIAN STOCK MARKET

SAN FRANCISCO (MarketWatch) -- Monsoon Capital LLC, a $1.2 billion hedge fund firm run by Gautam Prakash, has been hit hard by a slump in Indian stocks this year as overseas investors pull back from emerging markets in the wake of trouble in the U.S.
The Monsoon India Inflection Fund LP has dropped 28.3% this month, through March 20. That leaves it down 45.9% so far in 2008, Prakash wrote in an update to investors. MarketWatch obtained a copy of the letter.
The Monsoon India Inflection Fund 2 LP is down 26.8% so far in March and is off 44.4% so far this year, Prakash reported.
India's Sensex Index has dropped more than 26% so far this year. More than half of that slump has come so far in March, with the benchmark off almost 15%. Shares of smaller Indian companies have done even worse, with the BSE Mid Cap Index down 23% this month and 41% so far in 2008. The BSE Small Cap Index has plunged 26% this month and 47% year-to-date.
The performance of Monsoon's hedge funds and the broader Indian market show how vulnerable developing markets are to the waxing and waning of risk appetite among investors in developed countries.
Surging economic growth in India, China and other large developing countries has raised hopes of "de-coupling," in which such nations keep on expanding despite problems in the U.S. While that may turn out to be true for economic growth, it hasn't helped the Indian stock market, or Monsoon Capital.
"The U.S. is mired in a housing collapse, a severe credit crunch and turmoil on Wall Street that threatens the survival of several financial institutions and has compelled the U.S. Federal Reserve to take actions that it has not taken since the Great Depression," Prakash explained in his letter to investors. "These series of events and the size of losses have severely undermined investors, who have reassessed the risk premium associated with equities."
"Raising this investment risk premium to a higher level has triggered a correction in equity markets across the world; both developed as well as emerging markets," he added.
Despite recent signs of slowing slightly, Indian economic growth will still be very strong in coming years and the country isn't as dependent on exports to the U.S. as other developing nations like China, Prakash said.
"Though India is not export-dependent... and therefore should be relatively less economically affected than its Asian neighbors, investors are not drawing this distinction at this point of the crisis," he noted.
De-leveraging
A broader de-leveraging by investors across the world may be partly to blame for the Indian stock market slump and Monsoon's losses.
De-leveraging happens when investors that use borrowed money to buy stocks and other assets are asked by their brokers to come up with more cash or collateral to support their positions. Some investors have to sell holdings to meet such margin calls, which causes more price declines and, in turn, more margin calls and forced selling. See story on the Great Unwind.
Prakash said Monsoon has continued to see distressed selling by retail investors and speculators who had bought Indian stocks with borrowed money. Total sales by this group are now over $15 billion in the past two months, he noted.
Foreign institutional investors have sold about $3.5 billion of Indian stocks so far this year, Prakash also noted. These types of investors are crucial to developing markets. They pumped roughly $55 billion into Indian markets during the previous seven years.
Some of these foreign investors may have also been using borrowed money to invest in Indian stocks. They may be having to de-lever and sell positions too.
Emerging-markets hedge funds have been among the top-performing and fastest-growing part of the $2 trillion industry. It's common for hedge funds to use leverage to try to enhance returns.
Managers focused on India and China returned more than 50% last year, according to HedgeFund.net, which tracks industry performance.
Hedge funds are supposed to generate steady positive returns, even if markets are falling, because they use short selling, a way of betting against stocks and other assets. But it's more difficult to sell short in emerging markets.
Hedge fund managers focused on India lost more than 15% on average during the first two months of 2008, while funds focused on China fell 7.3%, HedgeFund.net data show