Can Ashoka India Equity continue its hot streak?

Large and influential as it has become, China has done more than enough to remind investors of its emerging market status in recent years. Fresh from what was seen as a successful lockdown strategy in 2020, last year Chinese authorities embarked on a flurry of regulatory interventions that saw some specialists conclude the market was uninvestable. Renewed lockdown measures and recent escalating tensions with Taiwan mean there has been plenty more in 2022 to disrupt an equity region once seen as reaching greater maturity.

For investors who view China as a standalone market to be accessed via single-country funds, this volatility matters. But it’s also a problem for Asian and emerging market funds: China makes up 36.1 per cent of the widely followed MSCI AC Asia ex Japan index and a similar proportion of the MSCI Emerging Markets index, and tends to feature heavily in funds investing across these areas.

As events in China have helped drive volatility in such indices, some investors are instead looking to another major Asian economy with a compelling story of its own. Funds such as Pacific Horizon Investment Trust (PHI) have placed a greater focus on India in the past year or so, following trusts such as Pacific Assets (PAC) to an extent. That's one way around the problem, but investors may still be concerned that many Asia and emerging markets funds come with too great a China risk, or simply wish to have a greater focus on countries which they think offer more potential.

The Indian market has certainly returned to form in the past year and, like Vietnam, is targeted by a few dedicated investment trusts. But if some established names like JPMorgan Indian Investment Trust (JII) have a track record going back decades, it's a newer entrant which has rewarded shareholders materially of late. However, as with other successful upstarts, you should consider whether its returns are sustainable as it gathers scale.

A quiet success

Just one of nearly 20 trusts to launch in a year that was ultimately one to forget for Indian market returns, Ashoka India Equity Investment Trust (AIE) comes from seemingly humble beginnings. It raised just £46mn at its 2018 launch, a modest amount compared to Smithson Investment Trust's (SSON) record-breaking £822mn initial public offering in the same year. But Ashoka India Equity has managed to grow since and had a market capitalisation of £205mn as of 8 August, compared with India Capital Growth Fund's (IGC) £106mn, Aberdeen New India Investment Trust's (ANII) £333mn and JPMorgan Indian's £610mn market capitalisations.

If growth has come from a combination of equity issuance and share price momentum, it's the latter and the trust's net asset value (NAV) gains which have really turned heads. During 2019, 2020 and 2021 Ashoka India Equity made share price total returns well ahead of the MSCI India IMI index's gains, including a return of nearly 50 per cent in 2021.

Alan Brierley and Ben Newell, investment trust analysts at Investec, described Ashoka as "standing out in a sea of mediocrity" in January this year, noting that just two out of 17 open and closed-ended India funds had come out ahead of their benchmark over five years. With its distinctive approach, they view Ashoka India Equity as a welcome addition to the investment trust space, especially as its asset base now appears to have gained critical mass.

The trust's investment process is focused on bottom-up stockpicking and tends to look beyond macroeconomic factors. White Oak Capital Management, which runs the trust's portfolio, has a large team of analysts and a proprietary analysis process. Helal Miah, an investment trust research analyst at Kepler Partners, observed in a recent note that the trust's investment process aims to "isolate recurring cash flows in a business once capital expenditure and financing costs are accounted for. [This should] flush out businesses that may have optically low price earnings but [also] poor economic characteristics and consequently suboptimal cash flows."

The trust's investment process aims to highlight companies which can generate superior returns on incremental capital, have a long-term scalable opportunity and are run by solid management teams that adhere to high standards of corporate governance.

The trust's investment team doesn't follow macro trends, or focus on specific sector allocations or investment styles. Analysis and research instead decides what ends up in the trust, although some sectors inevitably have a greater presence than others. Miah notes that energy and utilities have not featured in the trust, while financials, information technology and consumer discretionary stocks have tended to make an appearance, as have healthcare and industrials. For example, Ashoka India Equity's most prominent three holdings at the end of July were ICICI Bank (IND:ICICIBANK), Cholamandalam Investment and Finance (IND:CHOLAFIN) and multinational IT company Infosys (IND:INFY). Emerging markets fund manager favourite HDFC Bank (IND:HDFCBANK) also featured in the trust's top 10 holdings.

The trust has tended to have a bigger allocation to small and mid-cap shares than its benchmark, MSCI India IMI, and these are a reason for the investment portfolio being significantly different to this index. Brierley and Newell noted in January that the trust had an active share – measure of how much a fund differs from its benchmark index – of 76 per cent. Ashoka India Equity has also tended to be reasonably concentrated although this has changed over time.

A "premium" product scaling up

Kepler analysts describe the fund as a “premium” product, and some may think that description applies to its fee structure as well as its returns. Unlike most investment managers, White Oak Capital Management does not charge a yearly ongoing fee. Instead, it levies a performance fee of up to 30 per cent of NAV outperformance against the MSCI India IMI index over a discrete three-year period. The first such period ended on 30 June 2021 with the next performance fee payable on 30 June 2024.

While it's rightly controversial when managers charge both an ongoing fee and a performance fee, the structure used for Ashoka India Equity should incentivise its investment team to focus purely on picking winning stocks. It also has a remuneration system whereby the members of its analyst team are compensated on the basis of the contribution of their stock picks to the trust's portfolio returns. And the performance fee is paid out as shares in Ashoka India Equity.

The trust's returns have mainly powered ahead since launch, but the portfolio has stuttered slightly amid this year's volatility, with both its NAV and share price total returns underperforming the benchmark over the first seven months of this year. This may have opened up a small buying opportunity, with the trust’s shares on a very modest discount to NAV. They have tended to trade around par to the value of the underlying portfolio.

But one question, which applies to many young funds, is whether after having generated an impressive but relatively short performance record, its investment team can continue its stockpicking success as the portfolio matures. If the investment process and remuneration structures seem designed to produce further wins, it's worth noting that the investment team has already had to adapt its process in a way that could potentially affect performance.

In July, they changed the investment policy, effectively accepting that the trust will now have more holdings than it used to. The trust's board explained that new wording in the policy reflects "the expectation that the company's portfolio will comprise approximately 50 to 100 investments as opposed to approximately 25 to 50 investments as currently stated."

In fact, the trust has already expanded its number of holdings over time. As our analysis of monthly portfolio updates going back to the spring of 2019 shows (see chart), the number of holdings has risen while the weighting accounted for by the trust's top 10 holdings has fallen.

The reasons given for diversifying further seem sensible enough. When outlining the case for having more holdings, the trust's board noted that the small and mid-cap segment of India's stock market has a large and expanding number of listed businesses to choose from. More importantly, the trust's investment team believes that it will be "desirable to have small position sizes in a higher number of Smid [small and mid cap] businesses" for the sake of risk and liquidity management.

This seems like a sensible approach with a fund which already incurs big risks. Single country investing in emerging markets can be fraught with idiosyncratic troubles and concentrated funds are also exposed to stock specific issues. But, as with any young, high-octane fund with a concentrated approach, diversifying might prevent it from running its winners to the maximum possible extent. Yes, the trust's biggest position at the end of July, ICICI Bank, made up a sizeable 9.2 per cent of its portfolio and Infosys accounted for 5.5 per cent. But all the trust's other holdings accounted for less than 4 per cent of its assets.

You may also baulk at the prospect of a chunky performance fee or find it unusual that shares in an equity trust only rarely seem to trade at a discount to NAV. But niche as it is, Ashoka India Equity remains one to watch if you believe in India's story and what appears to be a pure form of stockpicking.