Fund managers in the in the IA Global Emerging Markets sector have overwhelming upped exposure to Indian equities over the past year, with more funds in the beleaguered sector overweight than for many years, according to research by FE Trustnet.
For several years the country was something of a pariah for investors in emerging market stocks as it was viewed as besieged by structural problems and poor liquidity that resulted in low returns delivered with high volatility. Not to mention, those looking for a high growth destination were also presented with a consensus belief China was the better long term bet.
Performance of index over 10 years
Source: FE Analytics
However, with the election of Narendra Modi last year all this changed as the reformer’s landslide win ushered in the promise of a new era characterised by freer markets, pro-business and investment promoting government policy as well as a huge plan to update the country’s lacklustre infrastructure.
To the surprise of the wider market, Indian equities rallied in the month before the election of Modi back in March 2014 and spent the rest of the year soaring by more than 60 per cent.
According to FE Analytics, this year following a short rally the shine came off the bull market and the MSCI India index, which tracks companies listed on India’s National Stock Exchange and the Bombay Stock Exchange, is now down 6 per cent over the year and 19.67 per cent since its high.
Performance of index since February 2014
Source: FE Analytics
Funds focusing on Indian equities dominated the list of top performing portfolios in 2014, with many hoping the rally would continue this year.
Currently of the 84 funds in the sector, 52 have an overweight positons – the MSCI Emerging Markets index is 8.39 per cent exposed to India – while one in six have more than double overweight and five funds have more than 20 per cent of their portfolios in Indian companies.
Funds such as the likes of Newton Global Emerging Markets (29.97 per cent), F&C Global Emerging Markets (25.3 per cent), JPM Emerging Markets (21.6 per cent) and SJP Global Emerging Markets (20.17 per cent) have the most exposure to India.
The biggest bull in the sector is the manager of £6.8m Neptune Emerging Markets fund Ewan Thompson, who has a whopping 40 per cent of his portfolio in Indian stocks.
Neptune, which is well known for its collaborative process in both stock selection and asset allocation, presumably has plenty of input from the £100m Neptune India fund which has seen huge inflows in the past 10 months.
Kunal Desai, who has managed the fund since December 2012 believes that the impact of cheaper oil and the emergence of an earnings and return on equity [ROE] "sweet spot" will be a huge boon for the Indian equity market above the policy agenda of Modi’s government.
Speaking at the latest FE Select event for emerging markets and Asia Pacific ex Japan, Desai said: “About 80 per cent of India's oil is imported, so clearly as you get cheaper oil the trade bill, the current deficit, should shrink further. Also a lot of government spending goes on subsidising the price of oil, and so that can be redirected to other areas."
“The vulnerability from rising US rates shrinks further and they have a once in a generation opportunity to shift spending from unproductive subsidies to far more productive, pro-growth and investment policies.”
“Most importantly is this sweet spot for earnings and ROE over the next two years. The reason for that is that there are three factors aligning that come rarely in an emerging market investment cycle.”
Manufacture utilisation - how much of existing capacity is being used up - has recently come down due to past sluggish growth and a period of over investment but the rate of capital reinvested has gone up and this is being married with high growth, he says.
"This means earnings margins have improved but at the same time companies are showing terrific capex and balance sheet restraint. When we think about what we are looking for - free cash flow - that convergence from emerging into free cash flow is being very much strengthened by this."
“The holy grail for investing is ROE and we are see this improve as utilisation move up but the amount of invested capital remains low.”
However the 14 per cent August falls of the Indian market may suggest the potential that the hope around Modi’s plan is more hype, according to Edward Smith, asset allocation strategist at wealth manager Rathbones, scuppering most emerging market funds given their partiality for overweighting India.
“[This raises] the uncomfortable possibility that the market has finally caught up with stunning failures in Prime Minister Modi’s reform agenda,” he said.
“In August, PM Modi capitulated on all-important land acquisition reforms. India has suffered from a dearth of capital investment over the last decade, in no small part due to red tape. Even the government finds it very difficult to procure land for much needed infrastructure projects.”
“Goods and services taxation is also unfathomably complex, as it is currently set by myriad local authorities. Reform here has been on the agenda for ten years, but PM Modi set himself a deadline for April 2016 to simplify the tax at a national level.”
He says with the need for greater clarification and an apparent lack of consensus from India’ numerous separate state governments, the deadline looks “unlikely to be met”.
“Despite a fall in the Indian rupee at the time of the capitulation on land reform, the index appeared immune from the equity rout in other emerging markets. The Indian market didn’t blink, until now that is.”
“This raises important questions about the basis on which much of India’s rise over the last couple of years has been predicated.”
Despite this worry Smith says there are plenty of reasons to be positive on Indian stocks, not least the huge fall in raw materials, most importantly oil.
“India is certainly not without its bright spots. It is a commodity importer with a low exposure to China, when compared to other emerging markets, just 4 per cent of total exports.
Performance of index since 8 August 2015
Source: FE Analytics
“It enjoys relatively high export exposure to the US and a recovering Europe, and reasonably strong domestic macro fundamentals that help immunise India from Fed rate hikes. But the reform agenda is way off track, so we continue to monitor developments. Meanwhile, we suspect that India is in for a more volatile time over the next 12 months.”