A slowdown in India has dampened investors’ appetite for the country, but fund managers insist now is the time to get involved.
India started to catch the attention of investors when Prime Minister Modi was first elected in 2014, promising to bring with him widespread reform. Indeed, he delivered on his pledge: clamping down on black market money, introducing a single country-wide sales tax, and ramping up spending on infrastructure. But uncertainty over whether he would win a second term of office in May’s elections put the brakes on the soaring success that India funds had enjoyed.
Sceptics say that many of the easy gains have now been made and India faces numerous headwinds in the form of rising oil prices (it is a major importer of the black stuff) and US/China trade tensions, which could affect the export-driven economy.
But it is the domestic story that fund managers have their eye on. India has a young population which is becoming increasingly wealthy, with a growing middle-class. And this structural trend creates huge opportunities for several sectors.
Kristy Fong, co-manager of the Aberdeen New India investment trust (ANII), says: “The domestic consumption theme is what we’ve always liked about India. It’s boring but it works. There is a young, growing middle class and we do not see that changing.”
Consumer Companies
To access this trend she invests in consumer goods companies; names which will be familiar to investors such as Unilever and Nestle, but which have separate India stock listings. These companies make everyday basics with strong brands, which benefit from increased household spending and should continue to enjoy sales regardless of a slowdown in the economy. But that comes at a price and shares are often expensive.
“But [Unilever] is the biggest consumer company in the country and still managers to grow faster than its competitors,” says Fong. “It has managed to grow its margins since the unified sales tax was introduced, something which competitors weren’t able to do, and it is an international company too so has very high standards of governance.”
Governance is, of course, a key issue when investing in any emerging market, where ESG factors are often less important to companies than growth. Fong is sure to conduct site visits and meet the management of any potential investment. “One time we went to visit a firm and the building was full of flies – that was a red flag,” she says. “I’m also wary if I meet a company boss and in his office there’s a Bloomberg screen with the firm’s share price. That suggests he’s more worried about short-term gains than the long-term future of the business.”
Instead she likes companies with a strong balance sheet, sound business model and which are growing in a sustainable way rather than just taking on debt. She likes private banks such as Kotak Mhindra Bank, which are well-run and better capitalised than government banks. While the latter has a 70% market share in India, that is shrinking.
Resilient Businesses
David Cornell, manager of the India Capital Growth trust (IGC), agrees the financial sector is a good way of accessing growing consumer wealth and should be resilient even in a slowdown: “People still open bank accounts, regardless of the economy.”
Another theme he likes is infrastructure, a major area of investment for the government as urbanisation continues at a rapid rate. He likes cement companies such as Ultratech and Skipper, which is involved in building telecoms towers and electricity pylons.
“We don’t like all areas of infrastructure though. We avoid buildings companies because they tend to have to borrow a lot of money upfront in order to win a contract to build, say, a road, which they won’t make profit on until its built and they start getting the tolls,” he explains.
He also has concerns about how some of these contracts are won. “We tend to avoid any area where there is heavy government involvement because we’re not quite sure what’s going on behind the scenes.” Recently he has sold a holding in Dewan Housing, a finance company focused on lending to lower and middle income borrowers.
Being a value investor in a fast-growth market is not always easy. The India Capital Growth trust currently trades at a 19% discount to its net asset value. While it has produced annualised returns of 4.9% over 10 years, it was down 24.9% in 2018.
Performance has been particularly weighed down by a handful of stocks in the portfolio but Cornell has been topping up his holdings in a number of these names, confident of their future prospects: “That’s what you do when markets are weak and unpredictable.” He has added to his stake in Skipper, Yes Bank, and Motherson Sumi, which has been hit by a slowdown in car sales both in India and the wider world.
Cornell says: “Growth has slowed dramatically in the past 12 months or so, and faster than we expected. That’s a concern but we also think it’s going to lead to much more sustainable growth in the future. What we have right now is real value – this could be the opportunity to buy a strong market at a cheap price.”
Ignore the Benchmark
Performance of the Aberdeen trust has been stronger – it has produced annualised returns of 11% over 10 years and delivered a modest return of 0.3% in 2018. Fong attributes that to the team’s willingness to deviate from the benchmark.
Reliance Industries, for example, makes up 10.8% of the MSCI India index but is not held in the trust’s portfolio. “It has become the number one telecoms player but by giving away free phones and data,” says Fong. “We don’t trust the numbers and we’re worried the owner family puts its own interest before those of shareholders. Maybe they can be the next Amazon in India but we think there are safer way to benefit from the trends.”
While avoiding Reliance, Fong has also been using the opportunity of a weaker stock market to put capital to work, investing in property developer Prestige Estates, for example. “It has a good brand and strong balance sheet and has been helped by regulations which have improved building standards and stopped some of the fly-by-night companies operating.”
Fong says: “The lag in performance this year has actually been good. Previously companies looked interesting but valuations were high, but now we can pick up good ideas at a cheaper price.”
