A domestic liquidity super-cycle is set to bolster India’s stock market in the coming months which means now could be a great time to buy into the country’s stock market, according to Neptune’s Kunal Desai. 
The manager, who heads up the five crown-rated Neptune India fund, adds that the quality of companies in the region is incredibly high despite misconceptions from UK investors that many firms adopt corrupt practices.
Investors have fallen in and out of love with Indian equities over the years. While the MSCI India index more than tripled the annualised returns of the MSCI AC World index in 2007, 2009 and 2014, it has significantly underperformed 2008, 2011 and 2014.
The index’s most recent spike happened as a result of the region’s 2014 general election, when leader of the Bharatiya Janata Party (BJP) Narendra Modi won by a landslide victory.
The pro-business prime minister pledged a focus on reforming India’s infrastructure, improving corporate governance and strengthening the country’s foreign relations.
These attributes of course sat favourably with investors globally and, in 2014 alone, the MSCI India index returned 31.58 per cent compared to the MSCI AC World’s return of 10.64 per cent and the FTSE 100’s 0.74 per cent.
Performance of indices in 2014
Source:FE Analytics
While this means the index has delivered strong total returns over three years, it fell behind the aforementioned marekts in 2015 as a number of investors questioned the speed at which Modi’s reforms were taking place.
Although the index has performed strongly in 2016 to date, why should investors believe that this trend is set to continue and is not simply because investors have temporarily ducked out of tenuous UK and European markets and migrated elsewhere?
Desai says that emerging markets have historically had a higher cost of capital as a result of greater political instability compared to the developed world although, given recent geopolitical events, he says that the equity ‘safe haven’ regions have altered.
“Now when you look at emerging markets they have a portfolio of very strong stable governments who are hell bent on reform or who have been elected on reform,” the manager said.
“This has been a change, not just that we’ve seen in India, but in Indonesia, in China to a degree, you can also see it emerging in Latin parts of America – Argentina in particular, there’s also improvement in Brazil.”
“So on the other side in developed markets here in the UK, we have political uncertainty with Brexit, in Europe there’s uncertainty in terms of EU referendum on their own EU memberships and also in the US there’s a big election taking place.”
“At the margin, we see a fall in the relative cost of capital of emerging markets versus developed markets simply because the political risk premium that emerging markets once had is beginning to shrink relative to developed markets.”
“Given how investors have been very under-positioned in emerging markets versus developed markets, that could be quite an interesting turning point that people certainly should be thinking about.”
While Indian equities have indeed done well versus emerging markets over the last three years, they have begun to fall behind recently as the market area has improved its performance. That said, it has significantly outperformed the FTSE 100 over recent time frames.
Performance of indices in 3yrs
Source: FE Analytics
Desai’s India fund has outperformed its MSCI India benchmark over one and three years as well as over the last one, three and six months.
The manager says India is still home to a large number of attractive opportunities despite the index’s spike in performance in 2014 but argues that investors need to look further down the cap spectrum to find them.
“Certainly from an Indian perspective, and I know a number of other fund management houses share this view, the country has the most capable management teams across the emerging world,” he continued.
“In fact, in the mid-cap space in which we’re invested, we’ve seen some of the best management teams that we’ve experienced both on a developed market and an emerging market basis. “
“One of the biggest misconceptions UK investors have I think is the ability of management to run their businesses.”
“Since 1991, India has been opening up its markets for foreign companies to come in and one of the reasons why a number of foreign companies have struggled in India is because they completely underestimated the ability of Indian management teams to manage their own businesses.”
Desai is able to invest across the cap spectrum within his portfolio but, following his three-silo approach to investing (which constitutes holding roughly equal amounts of companies set to benefit from structural growth, an economic recovery and self-help programmes), he has found himself significantly overweight mid-caps versus the benchmark.
Not only does he say that the quality of management from a bottom-up perspective is good further down the cap spectrum in India, he believes that there is a “domestic liquidity super-cycle” on the horizon in the region, which he says would benefit domestic-facing stocks.
“When we look at the past six years to the end of 2015 about $35bn has been invested in the market from both foreign and domestic investors. Essentially what we expect is two things – firstly that the savings rate picks up in India, just because of hyperactive central bank policy to stimulate savings by insuring we’re having positive, real interest rates which therefore incentivises people to save,” the manager said.
“This obviously is helpful for the market as a whole because capital pools deeper and therefore banks are able to channel that money back into productive means, which accelerates growth.”
“We also expect the amount that the average household saves and the proportion they hold in equities to move up. This is a reflection of rising animal spirits in India, people have made decent money in the markets since the change in government and also there are a number of equity participation schemes now being rolled out to encourage people to put money they save into equities.”
Desai says that the savings rate in India has moved up by 3 percentage points to 23 per cent and the percentage saved in equities has risen by two percentage points to 5.5 per cent. According to his team’s data, he says that this equates to around $75bn which is far more than what has come into the market over the last six years.
“That goes some way to show the sensitivity that the India market has towards this domestic money coming in and when it does come in, it’s the mid-cap and small-cap areas that we think will benefit the most,” he added.
Over Desai’s tenure, Neptune India has outperformed its benchmark and sector average by 25.33 and 50.15 percentage points respectively with a total return of 69.96 per cent.
Performance of fund vs sector and benchmark under Desai
Source: FE Analytics
Compared to its benchmark, the fund has a slightly higher annualised volatility and a higher maximum drawdown (which measures the most money lost if bought and sold at the worst possible times).
It has a clean ongoing charges figure of 1.01 per cent.
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