Technological change should be embraced and not feared, particularly when it comes to emerging market countries that have performed well recently, according to Baillie Gifford’s Andrew Stobart.
The investment manager, who is part of the team overseeing the Baillie Gifford Emerging Markets Growth fund, says there is a reason that the overweight in India mirrors the overweight in the information technology sector within the portfolio – to protect against a correction in the popular market.
Following the election of pro-business reformist Narendra Modi as prime minister last year, Indian equities have performed well, with the MSCI India index achieving total returns of 28.52 per cent over the last 12 months, beating the MSCI World and MSCI Emerging Markets indices by 7.61 and 8.72 percentage points respectively.
Performance of indices over 1yr
Source: FE Analytics
However, some investors believe the attractive qualities that the Indian market once held have now run their course, following nervousness over weak corporate earnings, rising oil prices and below-normal rainfall predictions for this year’s monsoon season.
So is India due for a correction or is there still room for growth?
“We’ve had quite a debate over the last year within the team: is this the start of a long-term structural growth period for India? Will Modi be able to push though some genuine long-term performance which will translate into a higher sustainable growth rate for the economy?” Stobart (pictured) said.
“This is versus those who are perhaps a bit more cynical and think this is another hopeless hope and that when expectations are actually met by reality, things will slow down in India.”
“So I think we are recognisant that we’ve had quite a cyclical rally. We think there’s still lengths to go though and we’re still watching what follows in terms of government action.”
However, despite a relatively upbeat outlook on India, Stobart feels the need to be very stock-selective when investing in the country.
Since the start of the year, the MSCI India index has plummeted below both the MSCI World and the MSCI Emerging Market index, returning just 3.72 per cent, which is less than half that of MSCI World and nearly a quarter of MSCI Emerging Markets.
Performance of indices since 2015
Source: FE Analytics
What’s more, a report released last week by Capital Economics argues that it’s no surprise that the Indian market’s equity rally is losing steam.
“There are a number of reasons to explain the reversal of fortunes. For a start, confidence over the government’s reform agenda may be waning a little. In particular, the finance ministry’s plans to retrospectively tax both foreign and domestic companies is likely to have unnerved investors,” the report stated.
“What’s more, the recent fall may simply be a correction given the previous strong run that Indian equities have been on. With this in mind, a spectacular rebound in equities seems unlikely.”
Despite the recent skittishness shown towards India, however, Stobart believes that the fund’s 11.3 per cent overweight to the country should not make investors nervous.
“I think, just breaking that down a bit, about half of that overweight is in IT outsourcers and we would argue that those companies aren’t really exposed to India because their markets are in the west and their costs happen to be in India,” the manager explained.
“These are the Indian IT service providers whose client base is primarily in America and Europe, so their revenues are predominantly in dollars or hard currencies, while their costs are predominantly in rupees.”
“[This means] they’re both a beneficiary of increased western spending and of a stronger dollar.”
The stronger dollar is a theme that runs throughout Baillie Gifford Emerging Markets Growth and this is shown through its 30.9 per cent overweight in the information technology sector.
Because Stobart and the rest of the team believe that emerging markets will face currency headwinds in the future, they hold companies which both benefit from sales to western markets and have an emerging markets currency cost base.
Their top holdings in light of this include Tech Mahindra, an Indian multinational provider of IT and networking technology solutions, and HCL Technologies, another Indian global IT services company that offers software consulting, engineering services and business process outsourcing.
The fund managers adopt a bottom-up stock picking process and focus on company characteristics as opposed to macroeconomics.
“One overweight which is a good example of our ability and desire to go off-index is Turkmenistan,” Stobart said.
“This is just one stock, Dragon Oil, which is a 4 per cent overweight. It was originally just Irish-listed and now it’s UK-listed as well.”
“It’s an oil company with its producing assets in the Turkmenistan part of the Caspian Sea and it’s really been an oil production growth story. It’s also now used some of the cash generated from those oil-producing assets to invest in exploration in countries such as Morocco, Iran and Afghanistan.”
This growth story is shown through oil-exploration giant Emirates National Oil Company (ENOC’s) move to buy out Dragon’s remaining shareholders last month.
“ENOC made an unsuccessful bid for the company in 2009, but the story is interesting because it’s a bit off the radar. We invested in a number of oil companies from between three to six/seven years ago when we saw opportunities which we felt were unloved by the market,” Stobart explained.
“One or two of them didn’t particularly work but Dragon very much has. It’s been more of a long-term production story. It now has close to $2bn of cash on the balance sheet, which has built up over the years, and has doubled its oil production over the last five years.”
Despite Stobart’s positive outlook on Dragon Oil, the energy sector currently has a 2.3 per cent underweight within the fund.
“It’s a bottom-up stock picking process but within emerging markets, because of the nature of the universe and because the macro is a bit more important, we do spend a bit more time looking at politics and also currencies which can play a big part in your returns,” the manager continued.
“The 2000s was a decade where you could have pretty much bought most emerging markets and done well. The rising tide which carried all the boats was on the back of Chinese growth and the increase in demand, particularly for commodities.”
“That has very much changed over the last few years since the financial crisis, in particular those countries which didn’t use the good times to reform and have now found themselves with problems and challenges.”
Stobart uses this approach to explain the fund’s significant overweight in the information technology sector, which is 26.8 percentage points more than the fund’s second-biggest weighting - the consumer discretionary sector - which has a 4.1 per cent weighting.
“You can’t just hug the index [in emerging markets],” he added.