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India poised for long term growth

Investing in India is a high-risk, high-reward opportunity for long-term investors
August 24, 2017

India recently marked 70 years of independence – but investors should be looking to its future. Of all the so-called Bric (Brazil, Russia, India and China) economies, India looks set to shoot ahead and investors should get in before valuations peak.

"Russia has become a bit of a pariah country in many ways and its economic model has been shown to be too reliant on energy prices," says Jason Hollands, managing director of Tilney Group. "Brazil’s model has also been shown to be too reliant on commodities and it seems to be mired in endemic corruption, while China is facing concerns about the growth of credit. But India looks in pretty good shape."

India looks poised to reap the global benefits of a growing middle class, a swelling working age population, nascent new technologies and a reformist prime minister. 

India’s annual gross domestic product (GDP) has risen from 5.5 per cent in 2013, before Prime minister Narendra Modi took office, to 8.0 per cent in 2016. And Mr Modi has not shied away from radical measures to tackle corruption. In November, the government introduced a surprise (and disruptive) demonetisation, which saw 85 per cent of the currency rendered null overnight.

The move had the added effect of pushing India at lightening pace towards becoming a digital economy. Meanwhile, the government has also created the largest digital database of people in the world with more than 1bn people recording and registering their iris and fingerprint signatures. 

"This has created the groundwork for the largest digital and financial network in any country in the world,” says Sam Lees, head of research at FundExpert.co.uk. "Bank accounts can be opened and fully functioning in 10 minutes and the government is trialling ‘frictionless and costless banking’: paying for goods with just your fingerprint, no wallet, no phone needed."

India also boasts a young population, with a median age of 28, and a burgeoning middle class. Brian Dennehy, managing director of FundExpert.co.uk, says: "India has an unbeatable combination of youth and reform potential that will drive superior returns for many years to come."

India's share of global manufacturing exports, at less than 2 per cent, remains tiny, but its more profitable service sector exports are growing, showing India has leapfrogged a stage of development. Its companies are prospering too. Citi Research estimates that Indian mid-caps (less than $4bn in market capitalisation) are expected to deliver earnings growth of 56 per cent in 2017.

Ed Smith, head of asset allocation strategy at Rathbones, believes India could match or outpace the growth China has achieved since the millennium. He says: "Capital formation [the build-up in stocks, assets and equipment] in India today is on a par with China's in 2000, which went on to increase fivefold. If India encourages research and development, we might see a similar explosion in patents and intellectual property.

"On many measures, India looks very similar today to China around the start of the millennium. How many investors kick themselves for failing to appreciate China’s potential early enough? How many wish they’d captured more of those China-related returns?" he asks.

Mr Hollands says: “India also has a growing middle class and pretty good educational standards, with a large graduate population. It is the world’s largest democracy and the rule of law is strong there, with a legal system that was very closely modelled on the UK system.  And alongside all that it has been enjoying a period of almost unprecedented political stability since the election of prime minister Modi.”

 

Indian stocks I love - BOX OUT 

Simon Finch, co-manager of Ashburton India Equity Opportunities Fund (LU1422756947), says a raft of sectors should be affected by the most recent radical reform in India, the Goods and Services Tax. This replaces multiple taxes levied by central and state governments. It aims to curb corruption, increase tax revenues and pull informal businesses – estimated to make up at least half of all businesses in India – into the formal economy. Unorganised companies will be incentivised to move to the organised economy and gain tax credits, which may outweigh the advantages of remaining in the shadows.

“Logistics is one sector where formalisation should be quickly forthcoming,” says Mr Finch. “Currently 95 per cent of logistics provision comes through the unorganised channels. However, tax credits are likely to promote formalisation of this sector, with those in the organised space better equipped to facilitate trading operations around the country.”

And with the government committed to tackling India’s fraying infrastructure, established logistical companies are set to benefit. Mr Finch’s fund holds two of the country’s leading providers – Navkar Corporation (NAVKARCORP:NSI) and Gateway Distriparks (GDL:NSI) - both of which are expanding operational capacity and making acquisitions.

“Gateway Distriparks also owns 40 per cent of cold storage operator Snowman Logistics, part of a sub-sector that will grow in significance in the coming years with close links to India’s urbanisation trend,” he adds.

END BOX

 

High valuations and short-term bumps

But whenever you’re investing in an emerging market there are certain risks you need to accept, such as higher volatility, typically lower corporate governance and the potential for developed market investors to pull their capital out all at once.

There are also particular issues specific to India to be mindful of. For example, as a net importer of oil, the country has received an economic boost from the fall in oil prices over the past few years. If that were to reverse it could have a knock-on effect on economic growth. Some parts of India’s banking sector have high levels of bad loans, which limits their ability to lend.  

And despite the progress the government has been able to achieve so far, there is still political risk. For example, the government may lose support or find it difficult to implement some of the measures that it is planning, such as land reform. More broadly, as India grows in economic strength this could lead to increased tensions with neighbours such as Pakistan and China.

"Reforms don’t necessarily mean a quick fix and there’s been a degree of frustration among some foreign investors about the pace of changes,” says Mr Hollands. “But political processes involve compromises and can be drawn out."

Meanwhile, the government’s radical reform agenda may lead to short-term slowdowns in market performance and growth. For instance, after the demonetisation on 8 November, India's two main stock indices – BSE Sensex and Nifty 50 – fell more than 6 per cent the following day. The move resulted in severe cash shortages for several weeks as people queued for hours to exchange their money for newly printed rupee notes.

"There are challenges and the near term might be bumpier than expected," admits Vinay Agarwal, manager of First State Indian Subcontinent Fund (IE0008369930). “[But] we think that the demonetisation move should not be viewed in isolation. Despite all the short-term disruption to the economy, we are now even more excited about the long-term opportunity in India and the stronger foundation that is being laid."

But he adds that valuations do seem high considering the possibility of short-term outcomes. The MSCI India index is currently trading on a price/earnings (PE) ratio of 22.40 times compared with a PE ratio of just over 15.45 times for the MSCI Emerging Markets and 15.55 for the MSCI BRIC indices. That means that valuations have further to fall if the performance of Indian companies disappoint. 

This is particularly the case within the small-cap space, according to Nitin Bajaj, manager of Fidelity Asian Values (FAS), which has its highest country exposure in India, based on a bottom-up stockpicking process.

"Valuations in the small-cap space look to be in bubble territory," he says. "Given current price levels, most of the [fund’s] investment is in the large-cap space. I stay away from companies where I do not find enough margin of safety. Return of capital is as important to me as return on capital."

Some of the large-cap stocks his fund holds include Power Grid Corporation of India (POWERGRID:NSI) and Housing Development Finance Corporation (HDFC:NSI), which is based in Mumbai and is a major provider of finance for housing in India. 

 

Funds to tap into India’s growth potential

Investors should not invest in India with a time horizon of less than five years due to the higher-risk nature of this market. An active fund could be a better option than a passive vehicle as active managers can get exposure to smaller companies, particularly those with a consumer focus that have strong growth potential.

Mona Shah, head of collectives research at Rathbones, says: "We have long since backed the consumer theme in India, and therefore favour managers who help us to express this theme. As India is a difficult market to get to know well and one that can suffer swings in liquidity, we seek managers that we think have a genuine edge when it comes to local knowledge."

With valuations high, she also prefers managers who incorporate a high level of valuation scrutiny in their investment processes to ensure they are not paying too much if earnings are not going to come through.

She suggests JPMorgan Indian Investment Trust (JII), which is managed by Rajendra Nair and Rukhshard Shroff and was the first UK investment trust to focus purely on India. With around £795m assets under management, it is currently also the largest India-focused trust. It has almost 40 per cent of its portfolio in financials and 18 per cent in consumer discretionary. It is trading at a discount to net asset value (NAV) of 10.3 per cent and has an ongoing charge of 1.22 per cent.

Another example is Jupiter India (GB00BD08NQ14), which has been managed by Avinash Vazirani since its launch in 2008. The fund invests in companies that operate or reside in India and may also invest in those that derive a significant proportion of business from or within India and companies based in Pakistan, Sri Lanka and Bangladesh. It has a low ongoing charge figure (OCF) of 0.69 per cent. Over five years it has returned 147.3 per cent, compared with 93.9 per cent for the MSCI India index.

"If you look at the Indian indices, they are concentrated in some large conglomerates and that’s one of the reasons I like Jupiter India as it has quite a bit - around 30 per cent - in small and mid-caps," adds Mr Hollands. "This fund is also run in an unconstrained way and so can really dive in to the domestic opportunities. It is well diversified with more than 90 holdings and the manager has a very long track record – with a good record of success."

Darius McDermott, managing director of FundCalibre, suggests Goldman Sachs India Equity Portfolio (LU0858290173). This fund invests in companies incorporated and/or listed in India. It follows an unconstrained approach that does not track its benchmark, the MSCI India Investable Market Index (Net Total Return, Unhedged, USD). And so the fund has a much larger exposure to small and mid-cap companies than the index; these make up 14.8 per cent and 25.3 per cent, respectively, compared with 4.7 per cent and 14.6 per cent in the index.

"Tomorrow’s winners won’t be those of today and it is only by going beyond the generic universe of market indices that investors will be able to properly capture these early-stage growth opportunities," says Mr McDermott. "The best active emerging markets managers spend a lot of time on the ground, researching first-hand the companies into which they invest and the market drivers. [Goldman Sachs India Equity Portfolio] exemplifies this approach."

However the fund has a higher OCF than the Jupiter India fund, at 1.06 per cent.

 

Broader emerging markets exposure

But depending on your risk appetite you may prefer to get exposure to India via a global emerging markets fund or a broader Asia-Pacific region fund as these offer more diversification than a single-country fund. Investing in a single-country fund is high risk and you will still be able to get high exposure to India though a fund invested in a wider region. 

India makes up just under 9 per cent of assets in the MSCI Emerging Markets index, but many emerging markets funds have a higher weighting than that to the region.

Mr Lees suggests Baillie Gifford Pacific (GB0006063233), which is managed by Roderick Snell and Ewan Markson-Brown. The fund is among the top performing in the Investment Association (IA) Asia-Pacific segment excluding Japan sector over one and five years. Indian companies make up 17.4 per cent of its portfolio, with India the fund’s third-largest country exposure after China and South Korea.

"The managers think India remains one of the most exciting growth markets in the world today,” says Mr Lees. "[They] expect it to be the fastest-growing large economy in the world, over almost all long-term time frames."

Mr Hollands uses Stewart Investors Global Emerging Markets Leaders Fund (GB0033874545) in client portfolios as a broad way of getting exposure to the Asian region. The fund is managed by Ashish Swarup and Tom Prew and its highest country exposure is to India, which makes up 26.2 per cent. It has an OCF of 0.92 per cent.

Mr Hollands also uses Stewart Investors Asia Pacific Leaders Fund (GB0033874768), managed by David Gait and Sashi Reddy. This fund also has its highest single country exposure to India, which represents 30.6 per cent of the portfolio. It has an OCF of 0.89 per cent. But the fund is among the bottom quartile of performance in the IA Asia Pacific excluding Japan sector over one year.

"Managers who are overweight India tend to be underweight China and that’s hurt them over the past year as China has bounced back strongly," Mr Hollands explains.

He also likes JPMorgan Emerging Markets Investment Trust (JMG) as it has an overweight position to India. The trust aims to maximise total returns from emerging markets worldwide by providing investors with a diversified portfolio of shares in countries and sectors. Its largest holding is in the Indian financial conglomerate Housing Development Finance Corporation. The fund is trading at a discount of 10.8 per cent and has an OCF of 1.16 per cent.

 

Performance 

Fund/benchmark/sector1-year total/share price return (%)3-year cumulative total/share price return (%)5-year cumulative total/share price return (%)Ongoing charge (%)
First State Indian Subcontinent 20.296.8196.81.94
Ashburton India Equity Opportunities20.180.6na1.12
Jupiter India20.094.7147.30.69
GS India Equity Portfolio23.795.7174.11.06
JPMorgan Indian*16.577.6127.51.22
Fidelity Asian Values*19.069.2125.51.33
Stewart Investors Asia Pacific Leaders8.042.074.90.89
Stewart Investors Global Emerging Market Leaders 10.436.858.30.92
Baillie Gifford Pacific 31.853.4102.20.74
JPMorgan Emerging Markets*18.652.463.11.16
Investment Association Asia Pacific Excluding Japan sector average20.047.475.5 
MSCI India 18.652.393.9 
MSCI AC Asia Pac Ex JPN 21.545.973.0 
MSCI Emerging markets20.737.450.1 
Source: Morningstar as at 17/08/17, *OCF provided by the Association of Investment Companies