India could be the star set to shine brightest within the rallying emerging market space due to more attractive valuations and stronger economic fundamentals, according to Architas’ Adrian Lowcock (pictured). 
The investment director says the country’s stock market is likely to have further to run despite concerns that the MSCI Emerging Markets index has already performed strongly this year.
For instance, he points out that India has lagged behind rallying regions such as Brazil and Russia year-to-date, which have been bolstered by the increase in commodity prices and formerly poor returns reducing valuation risk for investors.
Performance of indices in 2016
Source: FE Analytics
“The rebound in emerging markets has been driven by a rally in value stocks, particularly in markets which had been worst hit. Both Russia and Brazilian markets had suffered from political issues and were impacted by the collapse in commodity and oil prices,” he explained.
“India on the other hand has slipped behind as the initial euphoria of [prime minister Narendra] Modi’s election gave way to disappointment that changes were not likely to immediately impact the economy.”
Following five lacklustre years for emerging market equities, the sector rapidly gained popularity this year due to aforementioned commodity prices and heightened political uncertainty across most developed markets.
This, combined with historically high valuations across the likes of the US and the UK, led to many investors piling into the market.
Given that the MSCI Emerging Markets index has almost tripled the performance of the FTSE 100 and has outperformed the MSCI World index by more than a third in 2016 so far, investors could well be looking to trim their emerging market exposure rather than adding to it.
However, Lowcock says there are three main drivers at play for the Indian economy specifically, which could therefore have a positive knock-on effect on Indian equities.
Firstly, he says market valuations in the country are far cheaper on average than other emerging market countries and, while valuations are still high, says they are not particularly so for India.
“Relative to world and emerging markets they are pretty close to their long-term average,” the investment director said.
“That was when earnings were growing at less than 5 per cent. Earnings have been weak the last couple of years but are expected to grow in the double digits as reforms begin to have an effect.”
Lowcock also says the country’s GDP is strong, with the Indian economy growing by 7.3 per cent last year compared to 6.9 per cent in China and 3.1 per cent for the rest of the world.
According to the country’s GDP data, he says this is expected to rise to 7.5 per cent in 2017.
“India is also forecast to generate earnings growth ahead of other emerging markets over the next couple of years,” the investment director continued.
“In addition, India’s current account deficit has fallen from 4.7 per cent of GDP in 2013 to 1 per cent expected this year, whilst overseas debt is now 23 per cent of GDP. As such the country is less sensitive to rising US interest rates or a strong dollar.”
He says the third main driver for India is its favourable demographics, given that 55 per cent of the population are under 30 while 54 per cent are of working age, which he says will continue to rise given the skew to under 30s.
This is without mentioning Modi’s proposed reforms, which many investors worry will no longer happen given that he came into power in 2014 and few changes have come to fruition.
However, Lowcock points out that such reforms take time to get through parliament and to have an impact on the underlying economy.
For instance, he says the implementation of a goods and services tax, the increase in the number of Indian citizens with access to a bank account and widespread foreign direct investment are all set to improve corporate governance and boost the economy’s growth.
“There is still a long way to go before Indian reforms are complete and there are risks when investing in any emerging market. However, the reforms being made today could unlock India’s potential,” he explained.
“Much of the reform will help reduce corruption which has plagued the country and bring the informal economy into the mainstream. Modi is also making India a much easier place for companies to conduct business.
“The growth potential of India and indeed the growth already coming through is not currently reflected in the market’s valuations which are trading close to their long-term averages.”
In terms of funds set to benefit from this theme, the team at Architas particularly likes Fidelity Emerging Markets, which has a 5.8 per cent overweight to India relative to its MSCI Emerging Markets benchmark at 14.3 per cent.
Over the last five years, it has returned 50.85 per cent compared to its sector average’s return of 22.99 per cent and its benchmark’s return of 22.4 per cent. In terms of risk metrics, it is in the top decile for its annualised volatiltiy, its maximum drawdown and its downside risk over the same time frame.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
Lowcock said: “Manager Nick Price has a well-established process and is focused on investing in companies with superior growth potential, sustainable profitability and a consistent track record over time.
“The fund has a bias towards large companies but is able to deviate from the benchmark. The manager benefits from the depth of research and expertise at Fidelity.”
Another fund pick from Architas – but for the more aggressive investor - is Jupiter India, which has been headed up by FE Alpha Manager Avinash Vazirani since its launch in 2008.
Vazirani aims to find companies with strong long-term growth prospects that have been undervalued by markets.
“His process is mainly driven by detailed company research but he is aware of broader economic developments and themes in India, taking account of how these may impact companies,” Lowcock explained.
“Target companies typically have solid balance sheets and robust and sustainable business models. Vazirani runs a diversified portfolio, typically of between 80 and 100 companies.
“The fund has traditionally had a healthy weighting to small and medium-sized companies. Given the focus on India and exposure to smaller companies this fund should be considered riskier and may not suit all investors.”
Over five years, Jupiter India has outperformed its MSCI India benchmark by 45.58 percentage points with a total return of 95.33 per cent.
Performance of fund vs benchmark over 5yrs
Source: FE Analytics