Q: How is the PowerShares India Portfolio different from other India- focused ETFs in the market?

A: The PowerShares India ETF is based on the Indus India Index constructed by Indus Advisors. Indus India Index is the only fully investible index which takes into account foreign holding limits on Indian securities.

In the early 1990s India began its gradual transition from a socialist economy to a market economy. One of the many elements of that gradual change is the limit placed on foreign ownership of Indian companies at 24%.

In other words, foreign investors in the aggregate can only buy 24% of an Indian company (certain sectors have other limits). However, if a company wants to invite or allow additional foreign holdings, it could pass a board resolution to raise the limit from 24% to higher levels, and the new level becomes effective upon approval by the regulators. Currently, about 160 companies have raised their limits from 24% to a level between 25% and 49%; another 46 companies have raised their limits to between 50% and 75%; and 21 companies have no limits at all, i.e. , foreign investors can buy 100% of the stock of these companies.

The equity markets in India have about 6,500 stocks with a total stock market capitalization of about $1.5 trillion; the top 500 companies account for about 95% of this size.

The only way in which a foreign investor can invest in an Indian company is through an entity registered with the regulators as an FII--Foreign Institutional Investor. As foreign institutional investors buy and sell stock through the usual intermediaries, banks and brokers, RBI, the Reserve Bank of India, monitors all transactions on a daily basis so that the total foreign ownership is updated.

This was recognized as an important factor when we began to consider indexes for possible use as a basis for open-ended funds in the U.S. including exchange-traded funds. Until a couple of years ago, three indexes covered Indian equity securities: Nifty 50 created by the National Stock Exchange has fifty components; Sensex, created by the Bombay Stock Exchange, has thirty components; and MSCI India, currently with sixty-two companies. Each of them then had, and continues to include, some companies which have already reached their respective foreign holding limits. Therefore, if you want to create a fund in the U.S. based on any of these three indexes, you would not be able to totally replicate the indexes.

After some analysis and theorizing, we came up with a concept called, “Indus Cap.” There are two wellknown capitalization measures. Market cap is the total market capitalization of a company, being the product of the number of shares outstanding in a company and the price per share. Float Cap is the value of all shares available in the secondary market. Stocks that are locked-in and not available to the secondary market are excluded in Float Cap. Taking this one more step, if we remove shares not available to foreign investors, you get IndusCap. Thus, IndusCap is the capitalization in each company that is available to foreign investors.

Q: So IndusCap looks past market cap and float cap and focuses on the available float to foreign investors.

A: Correct. IndusCap takes into account not only the foreign holding limit for each company, but also the current foreign holdings. For example, if a company has a limit of 70%, and foreign investors already own 60%, then only 10% of the cap is available. This has to be modified, where necessary, by promoter-held and other locked-in shares.

Q: How is the Index constructed, starting from IndusCap?

A: We start with the largest 300 companies or so that trade either on the Bombay Stock Exchange or on the National Stock Exchange or both, and calculate their respective Indus- Cap values. The companies with the largest 50 IndusCaps are chosen for the Index.

First, the stocks are weighted by their IndusCap values. Then these weights are modified to meet the diversification requirements of RIC (U.S.) and UCITS (Europe). We then apply certain Sector limits, and change weights if necessary. The result is the Indus India Index.

Q: How often is the reconstitution and what happens on that day?

A: The Index is reconstituted quarterly. A more frequent re-constitution might result in a high turn-over. At the same time, we did not want to wait for a year (as most other India indexes do) because our index is sensitive to the current movements in the purchases and sales by foreign investors of Indian stocks. This is because, as mentioned earlier, one of the considerations is current foreign holdings.

Some of the information that we need comes from the quarterly corporate filings with SEBI, the Securities and Exchange Board of India, due at the end of the month following each quarter. Because this information is critical to the calculations, we reconstitute not at the end of the calendar quarters, but at the end of the months following the calendar quarters.

Q: How does the Index maintain its Investibility?

A: First, on each re-constitution date, only companies which have capitalization available to foreign investors are selected.

Second, if a company reaches its foreign holding limit between two re-constitution dates, it is removed from the Index, so that the Index remains totally investible.

There are two things to note in this regard: Because of the selection process, this event does not occur as frequently as experienced by other indexes. It has happened only four times in the past four years. Second, because low IndusCap companies are more likely to reach their limits, and low IndusCap companies have low weights, only a small part of the Index is affected by this event, infrequent as it is.