The retreat in Indian smaller and medium-sized stocks this year has been exacerbated by the collapse of lender IF&LS, according to India Capital Growth (ICG).
Ocean Dial Asset Management, which runs the £82 million investment trust said part of the recent economic slowdown in India was due to liquidity pressures after the collapse of AAA- rated unlisted non-banking financial company IF&LS in September 2018.
Virtually all mutual funds and banks were lenders to IF&LS. Since its collapse, most mutual funds have seen redemptions and have been exiting investments deemed risky. Banks have similarly become risk averse.
‘This is having a domino effect with the real pain being felt in the non-banking finance sector (NBFC) which relies on wholesale liabilities (mainly from banks and mutual funds) to fund asset growth,’ said the managers.
And this has rippled out to small and medium businesses, to which NBFCs are large lenders.
The collapse of IF&LS has therefore created nervousness among Indian businesses, with concerns of a liquidity crunch leading to defaults in areas such as real estate.
Any negative news on a company has been met with sharp stock price corrections and investors fleeing to ‘mega-cap safety’.
‘What has surprised us is the stand taken by the government,’ the managers commented in IGC's half-year results this week. ‘Both the government and the central bank have repeatedly stated that they are on top of the situation, that the problem is restricted to just four or five entities and there are no systemic issues.
‘The central bank has been infusing liquidity in the system and claims that there is actually a surplus in liquidity. If this is the case it is clear that it is not reaching the intended target.’
In the government’s budget in July, the Bharatiya Janata Party (BJP) said it would give a 10% first loss guarantee to banks for the next six months, on ‘high-rated pooled assets that they purchase from ‘sound’ NBFCs up to a total limit of 1 trillion Indian rupees’, as well as providing capital to public sector banks.
Ramesh Mantri, director of investments at White Oak Capital Management, manager of the rival Ashoka India Equity (AIE) trust, has been more positive about the liquidity squeeze, commenting recently that it was leading to more consolidation among NBFCs. This meant the ‘strong NBFCs [had] emerged even stronger, he said.
In the six months to the end of June, IGC’s net asset value (NAV) fell 5%, underperforming the BSE Mid Cap TR index by 2%.
However, a widening discount has seen the trust's shares trail 17% below NAV, having fallen 28% in the past year. The former top performer now lags its rivals with an 82% total shareholder return over 10 years. Aberdeen New India (ANII ) and JPMorgan Indian (JIII ), which focus on larger companies, have suffered more modest falls in the past year and over a decade have delivered 199% and 114% returns to their investors.
There has been a wide divergence in performance between large and mid-cap stocks, IGC said, continuing a trend from 2018. In the half-year period while the BSE Sensex TR index rose 10%, the BSE Mid Cap TR index fell 4%.
Following an initial post-election rally in markets sentiment petered off, mainly as a result of a slowdown in the economy. India’s gross domestic product (GDP) slowed to 5.8% in first quarter, a significant fall from the 6.6% growth delivered in December 2018.
Auto sales have slowed, while growth in consumer goods has almost halved to 4-5% and the trust’s investment manager Ocean Dial Asset Management noted a similar trend in consumer discretionary following discussions with companies in the sector.
The run-up to the general election, meanwhile, meant a temporary slowdown in government activity which had also spurred growth in previous years. Narendra Modi’s BJP was re-elected to office in May with a surprise second landslide victory.
In rural India, the slowdown was attributed to a dip in income caused by two years of weak monsoons as well as falling food prices due to the government trying to rein in inflation.
Despite negative sentiment pushing valuations below their historical averages, the managers are aiming to make the portfolio more concentrated, reducing holdings from 36 stocks to around 30 but instead increasing weights in the businesses which have the ‘strongest fundamentals’.
Detractors from performance in the first half were consumer goods company Jyothy Laboratories (JYOTHYLAB.NS), a 3.5% position, which lost a quarter of its value, while a 2.1% holding in private bank Yes Bank (YESBANK.NS) gave up 39%.
Manfuacturer Jain Irrigation (JISLJALEQS.NS), which accounted for just 0.6% of the portfolio, slid 63% and shares in fruit juice maker Manpasand Beverages (MANPASAND.NS), also a 0.6% position, tumbled 60%.
Positive performers were agri-sciences business PI Industries (PIIND.NS), 3.9% of the portfolio, which added 36%. A 5.7% position in Federal Bank (FEDERALBANK.NS) rose 16%, while IT provider NIIT Technologies (NIITTECH.NS), a 4.5% weight, gained 17%.
The 4% exposure to floor tile manufacturer Kajaria Ceramics (KAJARIACER.NS), jumped 18% and a 2.2% position in construction engineering company PSP Projects (PSPPROJECT.NS) climbed 40%.
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