India: Last BRIC Bright Spot via Matthews Asia
As the other three BRIC countries continue to disappoint, India moves ahead. By Marla Brill, Financial Advisor
A few years ago, China provided a strong tailwind for the emerging market story. Recently, it’s been more like a ball and chain. In the three months ended September 30, the MSCI China Index fell 23% (in U.S. dollars), and over the last three years annualized returns averaged less than 1%. By contrast, India’s market fell just 7%, and rose an annualized average of 2.73%, over the same periods.
As economic growth in China continues to disappoint, sending shocks through world markets, growth in India is moving ahead. In April of this year, the International Monetary Fund predicted that India is set to overtake China as the fastest-growing major emerging market, with a forecast of 7.5% GDP growth in 2015 compared with China’s 6.8%. The IMF also sees stronger growth for India than China in 2016.
This front-runner status comes as Brazil and Russia, the large commodity-exporting components of the BRIC countries, continue to suffer from falling commodity prices. By contrast India, which imports most of its oil and other commodities, has benefited from lower prices. Another driver for India’s stock market was the election of Prime Minister Narendra Modi in 2014, which promised to bring needed government and business reforms.
All these factors helped push the MSCI India index up 26% for 2014 even as the MSCI BRIC Index fell slightly. Following this strong performance, foreign institutions put almost $6 billion into Indian stocks in the first three months of 2015 alone, compared with about $16 billion for the entire previous year. India ETFs and mutual funds have also seen strong inflows.
Sunil Asnani, manager of the $1.5 billion Matthews India fund, has mixed feelings about all the attention and is somewhat skeptical about India’s status as the new poster child for emerging markets. “Over the years, India has been subject to excessive optimism and excessive pessimism,” he says. “So this is nothing new.”
The 40-year-old Asnani’s observations come from years of experience both as a native-born Indian and an investor. His path to managing the fund started when he joined the Indian Police Service in Trivandrum, India, in the late 1990s after graduating from college with a degree in engineering. “There were a lot of very smart people out there with engineering degrees, and I wanted to use my people skills,” he says of the unusual career move.
After five years, which included a stint as superintendent of police, he headed to the University of Pennsylvania’s Wharton School of Business to obtain a master’s degree. After graduating in 2006, he worked for two years as a corporate finance consultant with McKinsey & Co. in New York before moving to San Francisco-based Asia investment specialist Matthews as a research analyst in 2008. He became lead manager of the India fund in 2010.
Fluent in several Indian dialects, Asnani says his background gives him a different perspective from most investors. “I have to say I am more skeptical of Indian companies than non-Indian investors, and I don’t take management statements at face value,” he says. To gather on-the-ground observations and speak to managers, he travels to India at least three to four times a year.
Given India’s corporate and government cultures, his skepticism is well-founded. Families virtually run many listed companies through seats on the board, which creates potential conflicts of interest and disputes among chief executives, shareholders and board members. Although India is a democracy, data from the last three federal elections in the past decade shows that more than one-quarter of elected representatives face criminal charges, in part because criminal underpinnings intimidate opposition voters, especially in poorer regions.
Inconsistent and excessive regulations add to the problems. Historically, the country has been held back by a tangle of over-complicated, poorly implemented laws dating back to its independence and extending into the 1990s. Although there have been some policy improvements, rules governing land and labor markets remain restricted by red tape. Investors have been optimistic about Modi’s pro-business attitude, but Asnani believes the Modi government has yet to go as far in shaking up India’s bureaucracy as much as people were expecting. “I feel on a scale of 1 to 10, Modi has delivered about a 4 or 5,” he says.
India’s demographic profile
India’s much-touted demographic profile, which is younger than that of other emerging market countries, may not necessarily be a plus, either. “On the one hand, a younger population opens up the potential for a bigger labor pool, greater productivity and a larger tax base,” says Asnani. “But without proper training and infrastructure, those things might not materialize to the degree many people hope for.”
“No doubt India has great potential and the wherewithal for rapid economic growth for decades to come,” noted Matthews research analyst Sudarshan Murthy in a report earlier this year. “However, long-term investors need to monitor changes in the underlying institutions.”
There’s also the issue of valuation. Given India’s strong performance relative to other emerging markets, especially in 2014, some observers believe that a great deal of good economic news has already been priced into its market. Asnani points out that India has historically been relatively expensive for the emerging markets for a few reasons—because of the higher quality of its corporate sector, because it doesn’t depend on commodities and because of technical factors such as its restrictions on short selling.
But even by historic standards, the Indian market seems to be hitting its upper limit. “Usually the Indian market trades at 17 to 18 times trailing earnings,” he says. “Today that figure is 20 times, or more.” And while India’s market has been less volatile than usual lately, it is typically even more volatile than other emerging markets.
That volatility works for the fund by helping Asnani buy stocks on dips. He targets companies with the financial stability, transparency and management to do well whether or not government reforms materialize or occur more slowly than expected. Other desirable characteristics among his target companies include strong market share and strong and rising expenditures on research and development as sales grow.
Although the fund is classified as an all-cap offering, it holds more small-cap and mid-cap names than most India indices and mutual funds. Asnani likes them because Wall Street analysts typically don’t follow them and they trade at discounts to large-cap stocks. According to the latest fact sheet, the fund has a 50% allocation to small-cap stocks with $3 billion or less in market capitalization. That’s significantly higher than the 4% for its benchmark, the S&P Bombay Stock Exchange 100 index.
Asnani is a long-term investor whose typical holding period is five to seven years. “In emerging markets such as India, managers are increasingly trading companies rather than investing in them,” he says. “We believe a five-year holding period is necessary to consistently benefit from both bottom-up and top-down drivers of returns.”
The portfolio is underweight relative to its benchmark in areas whose fortunes hinge on unpredictable and capricious government policy, including the infrastructure plays that have been so popular among both domestic and foreign investors. Asnani has avoided such companies because they face heavy competition, lack pricing power and depend on government policy and official favor. There are also incentives for corrupt corporate practices in the sector. The fund also has no presence in utilities or telecommunications and energy companies, whereas altogether these have an allocation of about 13% in the benchmark.
On the other hand, the fund is overweight in sectors that depend less on government reforms and stand to benefit from strong domestic consumption, including consumer goods, health care, technology services and select industrials. Among such holdings is specialty pharmaceutical company Ajanta Pharma. Headquartered in Mumbai, the 43-year-old company has cut costs by outsourcing much of its manufacturing and plowing the savings into research and development. The company has an extensive presence in India as well as many countries in Asia, Africa and Latin America, and it is just beginning to crack the U.S. market.
Another fund holding, Symphony Ltd., offers a wide range of air coolers and air conditioners. Founded in 1988, the company has a 50% share of the market in a country dogged by oppressive heat. The fund began buying the stock a couple of years ago, and the price has risen about sixfold since then.
Cognizant Technology Solutions is one stock representative of India’s well-known technology services arsenal. Although the company trades on the Nasdaq, 90% of its operations are based in India. The fund added the stock after a correction in 2014 brought the price down to an attractive level.
Industrial holdings include Gujarat Pipavav Port, which runs the Port Pipavav shipping facility. Ten years ago, global shipping giant AP Moller-Maersk acquired a 54% stake in the port and made significant investments in port machinery and infrastructure expansion, and in 2010 the company went public with an IPO listing on the Indian stock exchange. Asnani says the company boasts strong, transparent management, well-run facilities and a key location that serves key markets in India and offers room for expansion.