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Challenges and opportunities – can India continue its growth path over the next 5 years?

21 December 2023

India's relative investment prospects on the global stage look good right now.

By Andy Draycott & Abhinav Mehra,

Chikara Investments

Five years ago, India accounted for a mere 0.87% of the MSCI AC World Index. Now, (as of June 2023) that figure has more than doubled. When we established our strategy five years ago, with the aim of capitalising on domestically focused investment opportunities in one of the fastest-growing countries in the world, little did we know that the subsequent five years would bring an array of challenges.

Ranging from the failure of a quasi-sovereign finance company in India, which adversely affected some banks and non-banking finance companies, to geopolitical tensions with nuclear-armed neighbours – first with Pakistan in 2019, and later with China in 2021-22.

The period also witnessed domestic elections, international conflicts, and a once-in-a-century pandemic. These events were unforeseen 'risks,' and proved to be more impactful than traditional concerns such as oil prices or domestic inflation.

However, we also learned that risks can present opportunities. As active managers, we embraced the wisdom of Vladimir Ilyich Lenin, who once said, ‘There are decades where nothing happens; and there are weeks where decades happen’.

The onset of Covid-19 was one such transformative event but it gave us the opportunity to invest in sectors that were under duress at the time, such as travel and tourism, during the initial lockdown in India. Investing in a low-cost airline, a premier five-star hotel chain, and a luxury shopping mall operator, have since proved to be prudent.

In the same vein, we saw the shift from ‘growth’ to ‘value’ that began in late 2021, impacting domestic-facing new-age tech businesses after their initial public offerings (IPOs). Although maintaining our conviction during these times was challenging, adopting a hands-on approach, close engagement with management teams, backing sector-leading companies, and cutting through the noise, was vital.

Five years on, experience has shown us that some of the most significant sources of alpha can be derived from strategic actions taken during these turbulent periods. Another key lesson is aptly summarised by Carveth Read's adage: ‘It's better to be approximately right than exactly wrong’.

As at 19 November 2023, India's GDP has increased by 38% over the same period and we would expect that to continue over the next five years and beyond. It is noteworthy that we have had minimal exposure to two sectors (namely, IT and energy) that drove approximately half of the benchmark's returns. We believe the future of traditional IT depended more on global growth than on Indian growth.

Despite experiencing a boom during Covid-19 due to increased outsourcing, these companies now face an uncertain global demand environment and disruption from artificial intelligence (AI) and platform-based solutions.

In contrast, our e-commerce and fintech exposure in the fund, now the second largest theme after financials, comprises domestic-facing new-age tech businesses leading in areas such as food delivery, online insurance, payment processing fintech, e-commerce logistics, and online beauty and cosmetics.

India’s valuation and outlook

A frequent concern raised by investors is India's valuations being higher than those in most emerging markets. We interpret valuation as a reflection of a business’s discounted future cash flows. In sectors where penetration rates are typically below 10%, if a business executes its strategy effectively and increases its market penetration over time, its cashflows and earnings could multiply several times.

From this perspective, a 20-25% higher price-to-earnings (P/E) multiple on current year profits seems an almost negligible factor for determining the potential of businesses in nascent categories. This is particularly true for India, where the capital expenditure and property cycle look like it is just beginning to revive after an approximately 10 year lull, and profit margins remain at roughly half of those in the US.

More fundamentally, we believe that long-term returns are influenced by time in the markets rather than timing the markets. Predicting market dips and waiting for the opportune moment to invest can be precarious.

In the current environment, even with a 5% potential gain from holding cash for a year, we believe a strategy of making initial investments and then adding to positions during market pullbacks is more prudent, particularly as India continues to deliver on its growth promises.

 

Looking ahead: The next five years

India's relative investment prospects on the global stage look good right now. The past five years have demonstrated India's unique position within emerging markets, characterised by a large economy, significant growth potential, favourable demographics, low debt levels and is experiencing the beginnings of a revival in its domestic property and capital expenditure cycles after a lost decade.

In contrast, China – the predominant weight in emerging markets – is grappling with high debt and a rapidly aging and declining population, necessitating new growth drivers.

In comparison to developed markets, India presents a striking contrast over the next five years. Most are burdened with high debt, aging populations, rising taxes, struggling infrastructure and the economic adjustments required to transition from a decade of zero interest rates and low inflation to an era of rates above 5% and high inflation.

It is best to close with a quote by Bill Gates that is apt in the context of investing in Domestic India – ‘Most people overestimate what they can do in one year and underestimate what they can do in ten years’.

Andy Draycott & Abhinav Mehra are co-managers of Chikara Indian Subcontinent fund. The views expressed above should not be taken as investment advice.

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