A breathtaking digitalisation programme has augmented India’s demographic advantages and turned it into a global growth powerhouse, explains Gaurav Narain, investment adviser to India Capital Growth (IGC ).

Find out more about what is driving India’s growth to become the world’s third biggest economy in seven years by watching this one-hour recording of Citywire’s virtual event with India Capital Growth last week.

The programme contains:

• Narain’s 20-minute presentation;
• interview of Narain by Citywire’s Gavin Lumsden;
• Narain’s answers to live questions from the audience.  

Can’t watch now? Read the transcript!

Gavin Lumsden (GL):

Hello and welcome to ‘India’s Growth Story Has Only Just Begun’, a one-hour programme brought to you by Citywire and Ocean Dial Asset Management. My name is Gavin Lumsden, I’m from Citywire and I’ll be presenting today’s show. My guest in the studio is Gaurav Narain, co-head of equities at Ocean Dial, which is based in Mumbai. Gaurav is portfolio adviser of India Capital Growth Fund, a London listed investment company whose portfolio of mid-cap stocks in India, he’s run for 11 years. Gaurav, very good to see you, welcome to Citywire.

Gaurav Narain (GN):

Thank you, Gavin.

GL: This is an excellent time to hear from Gaurav, as just this week, Ocean Dial announced it was being acquired by AssetCo, the UK fund management consolidation vehicle of Martin Gilbert, best known as the founder and former chief executive of Aberdeen Asset Management. In words that perhaps, could have been lifted from Gaurav’s presentation, Gilbert said, he was drawn to the deal by the, ‘long-term potential that India offers.’  Today, we’re going to look at what that long-term potential consists of. If you’re a regular viewer, we’re following our usual format. After my introduction. Gaurav will give a 20-minute presentation. I’m then going to ask him a few questions and after that, it’s over to you for Q&A in the last section of the show. That’s enough from me. Gaurav, hello again, are you ready to tell our viewers about India and the investment trust?

REFORM AND GROWTH

GN: Sure, what I’ll do is, I’ll take you through a short 20-minute presentation and really tell you the whole story of India and why we feel that this is just a big name. So really to start, I thought I would just introduce you to what we do. We invest only in Indian equities. The investment team, including myself, are based out of Mumbai. We invest only in the small and mid-cap space. This is a space where we see a lot of opportunities. A lot of companies coming in for listing. A very wide universe of companies. More importantly, it also suits our investment trust structure because we can actually buy business which are very small-cap in nature which may not be very liquid, but since we hold it for a long period of time, these businesses truly compound over time.

So, before I begin, I thought what I’ll do is, I will just give a perspective of where India stands today. The best way to do it is really compare it where India is versus the UK. I think three things standout. If you see, India is a very young population, 600m people, average age below 25 years. In terms of size of the economy, India is similar to the UK, but if you look at the growth rate, it’s significantly higher than the UK. The third aspect which really stands out is that India is actually, not a leveraged economy, even on the household debt, it’s very, very low.

If you go broader and look at it from a bigger picture, what I’ve done is, I’ve compiled data from the World Bank, which is actually ranked companies in terms of size over different five-year periods. Going back as well as they see it going forward. What you’ll see is that the orange line is that of India and you’ll see that virtually in every time period, India’s rank has doubled. No other economy can you see such a jump. Today, in fact last year, we crossed the UK in size with the fifth largest economy today. I think what’s more interesting is if you look forward. Over the next decade, India will become the third largest economy. It will really take over from Germany and Japan as well. So really, I would say that’s the bigger picture story.

Looking more at the shorter-term horizon, I also thought I’ll compare what the IMF forecasts are for the current year, as well as going into the next year. Here too, you’ll see among the large economies, India is the fastest growing. Not just that, it’s actually growing much faster than China, even after China has increased its growth forecast. So really, what is driving this growth and our own sense is this is fairly structured, it’s fairly transformational and we’re really entering the beginning of the next growth phase. Why do I say that?

To answer that, I would say you have to really go back in time. When the [Narendra] Modi government came in 2014, the first four, five years they used really for making a lot of transformational reforms and they had the ability to do that because they came with a majority share of votes. The sorts of reforms that happened were fairly transformational. It covered virtually every sector of the economy. To highlight two, three, four areas. The first was on the taxation system. The entire taxation system was revamped. It’s really a lot of online matching of invoices and the banking system was reformed. The biggest, I would say, was on the real estate sector, which again, became very, very transparent. The whole idea of the reforms really was to improve transparency. Use a whole host of technology and in the process, I would say there were over 300-odd reforms. Over 40,000 regulations and compliances have been removed. So, India, really the idea was to make India a better investment destination and really, to encourage businesses.

What that also led to was that the old way of doing business, virtually changed all the businesses which really played the banking system and multiple companies had dubious dealings. You saw a number of these businesses collapse. So, in the short-term, you saw a lot of uncertainty at the end. Really, that affected growth of the economy. To give perspective, if you see the chart on the left, that’s the banking system on performing assets. In that period, you saw the NPAs [non-performing assets] of the banking system move all the way up to 6%. Since then the banks have really been cleaning up their act, largely also driven by the reforms which were introduced, that they really had no choice. Everything was digital. Today, the banks are sitting on the cleanest asset quality they’ve had in the last decade. So really, they’re in a very strong position to invest again.

The same can be seen on the chart on the right. This is the corporate profitability, which also collapsed, largely because of a number of businesses which went bust, but it also led to a lot of consolidation. So, the strong became stronger and at the same time, most businesses looked inwards, started deleveraging their balance sheets. So today, when you’re in the current environment, corporate profitability’s again back on the mend. Capacity utilisations have picked up and companies are also in a position to invest. So that’s where we are because of the reforms.

INDIA STACK

I’d also like to highlight one very interesting development, really on the reforms. What also happened. is that India has really digitised its economy over this period as well. I would say, possibly, India has some of the-, I would rate India’s digital infrastructure …

[TEN MINUTES]

… at par or better than any other country in the world. It’s called the ‘India Stack’ today. To give you a perspective, it really started with the government coming out with an identity for every Indian because they found that most Indians, if you were born in the city or in rural, small towns, you actually didn’t have an ID, you had no passport, you had no birth certificate. So, they really went about creating an identity for everyone.

So, it was called the Aadhaar card where you had a unique number. You had your fingerprint, you had your photograph, you had your retina scan and that was used as a KYC, know your customer for all sorts of approval processes. 1.3bn Indians have this unique identity number today and from that, the government said look, let me now get a bank account for every household. So, if you’re living even in a rural area, banks were really forced to open bank accounts. So, one bank account, at least, per household. In this period of three, four years, almost 450m bank accounts were opened. That created the base of the India Stack. Since then, they’ve come up with a platform called the UPI, which is like a payment gateway. It’s a very high volume, zero cost payment system.

You can do a peer-to-peer transfer of money, you can do a peer-to-merchant transfer of money, merchant-to-merchant transfer of money at no cost. So you know, what it’s done is that today, you’ve actually got rural India or small town India, small shops into the masses. So I can make any payment today, every shop you go to India will have a QR code. You just scan it and pay it, it could be as low as ten cents, the transaction value. To give you a perspective, if you see the global real-time payment transactions, 40% of volumes are in India. That’s the scale this has driven. On top of that, they built layers upon layers. For example, when Covid happened, India was able to administer a billion vaccines in nine months flat. The reason was simple.

They created an app called Co-WIN. You used your identity number to identify the closest hospital or wherever a delivery of vaccine was happening. You went, fixed an appointment, got the vaccination and your certificate was uploaded instantly. So really the government is building more and more stacks, which are really getting the whole country together. Simply it’s very high volume, very low cost. I can just go on and on about this, but this has really changed the nature of the economy in a large way.

MANUFACTURING INCENTIVES

So now, having done all this background work, I think the focus of the government today, is on growth. They’re doing it through two ways. The first is a massive infrastructure rollout. So, India, today, I would say the construction zone, you have about $1.8tn worth of projects happening over this next five years. To give a perspective, in Bombay itself, there’re about $50bn worth of projects happening in and around Bombay itself. From nine metro railway lines are being constructed. There’s a greenfield airport being constructed. We have two greenfield expressways being built. One all the way to Delhi, one to the centre of a city called Nurpur. Most of this is being actually funded by the government itself along with other agencies.

So that’s what started the growth journey. Then the government said we have to kick-start the growth and the corporate sector was still in a very uncertain mode. Since then, what they’ve done is to encourage the corporate sector itself. Now, they’re coming up with a lot of policy measures, which are giving incentives to the corporate sector to invest. So they’ve come out with a scheme called the Production Linked Incentive Scheme, which came out about two years back, where they identified 14 different industries and within that subsector where they felt India’s a very large base. Where we’re importing a lot of products or we have a very strong manufacturing base which can be used for an export base.

So, for example, one of the areas they chose was cell phones, where we have an annual market of almost 160m smartphones. 80% used to be imported. So they came up with a policy measure which said that if you invest X amount each year for the next five years and have incremental revenues of a specific amount, we’ll give you a 5% to 7% subsidy on the revenues. You won’t believe it, in these two years, you’ve got ten such companies which have taken advantage of it, all three of the Apple manufacturers have set up shop. Apple itself, last month we saw about a billion dollars of iPhones exported. Their own target is that 25% of the production would be in India. This is really going on into multiple areas, also. It’s in textile, it’s into chemicals. Very, very specific identified areas where India can become a big base. You’re seeing that actually starting the capex in the private sector also.

RESILIENT GROWTH

So I think from a growth perspective, I think a lot of measures are already in place and we can also see that in the numbers. I mentioned about the banking system, but if you see the credit growth in the banking system today, it’s running at 16%. It’s actually at a seven year high. If you see the tax collection by the government, it’s possibly the first time where we’ve heard that the government tax collection are running way ahead of their own forecasts. So, both direct and indirect taxes, growth is almost at 20%. It’s really reflecting the pick-up in the momentum of the economy that you’re seeing. As I mentioned earlier, it’s not just a short-term phenomenon.

On top of that, I come back to demographics. What you see in India is today, you have a working population of over 500m people. There are about 10m people coming into the workforce every year. You’re talking about 100m people being added over the next decade on the workforce. So, India’s one country where you’re not having an aging population. I think all the way to 2070, you don’t really have a people issue and that’s really going to drive your consumption. I’d like to add, if you see the slide on the right, our per capita income is just $2,300. It’s one sixth of China. So the potential, once you see the growth pick-up on the economy, you’re going to really have a big inflection on the consumption side as well. So, I would say all ingredients are in place.

Having said that, I thought I will just address two key burning issues everyone has today. That is really on how India’s responding to this global macro environment. I would say it has been fairly resilient and I’d say for two reasons. The first is that whenever there’s been a global crisis, India, because it has a current account deficit, reason being we import 85% of oil and that’s 20% of our imports, the currency is the first thing which takes a big hit. In this chart, I’ve plotted India’s currency versus the US dollar over the last 25 years. What you’ll see that in every crisis, the currency depreciates between 20% to 30%. See the top corner on the right, in this crisis over the last year, our currency has depreciated only about 10% to 11%. It’s actually appreciated versus the pound and the euro.

The reason behind that is that structurally, India’s balance of accounts is far more stable. Today, India has reserves of over $550bn. It’s the fourth largest reserves in the world. This has really been accumulating because India, because it’s getting a lot of long-term capital. In the capital account, you’re getting foreign direct investments of almost 75 to $80 billion per annum and that’s not volatile money, it’s really stable money going into core infrastructure, etcetera. So I would say a lot more resilience and this is really reflective of how much stronger the economy is as such.

I think the second issue, which people talk about is inflation, which is really the pressing problem in the western world. So, what I’ve done is, I’ve compared the inflation of India, which is the dark blue line with that trending in the UK, EU and the US. What you’ll find is 1) India’s inflation is actually lower than most of the countries, but I think a more interesting factor is if you go back in time. Pre-2015, India inflation used to trend much higher, at almost 8% to 9%. So, while the central bank has raised rates by 250 basis points to about 6.5%, it’s not a talking point, it’s not hurting the economy. People are used to higher rates. In fact, what I’m really trying to say, it’s not impacting demand as yet. Even your mortgage rates are much below what they used to be historically. So, I would say, so far, it’s not really as much of a worry as what you’re seeing in the markets in the west.

LOW PORTFOLIO TURNOVER

So having said that and the opportunity we see. Really, how are we playing this in our portfolio?  So, to give you a snapshot. What we really do is, we are very much bottom-up stock pickers. In fact, 90% of our portfolio is active shares which essentially means that if a stock is an index, does not mean we need to buy that stock.

[TWENTY MINUTES]

We invest with a very long-term mindset. So every stock we look at, we say we should be looking at it from ownership of at least three to five years. Over 65% of our portfolio companies I would say we’ve owned for almost five years, if not more. So, the portfolio turnover is very low, but the base of our investment strategy is that we do recognise that India has a lot of growth opportunities. So, all you really need to do is identify the right management. Identify which really are scalable and have some moat to it. Very focused on cashflows and have a threshold return on capital employed so you’re structurally buying strong businesses and we’re very, very conscious of ESG. So, we need to really eliminate any business which we find have any iota of governance or environment issues which could be a risk to the future of the portfolio.

GROWTH BUCKETS

So, on the portfolio itself, what we typically do is, we bucket our portfolio into four different areas. The ones on the left, which is our consistent compounders, this is what I would say form the core of the portfolio. I’ve mentioned four stocks here, but each of these, we’ve owned for almost eight to ten years. For example, PI Industries. This is an agrochemical company, but very strong on R&D. So they actually work with global innovators across the world on their own R&D and if a product is commercialised, they’re the suppliers to them and also, then they launch the product in India under their own brand. Now, this is a company which has been growing its earnings at almost 20% per annum over the last decade. More important the outlook is even brighter because they’re actually moved beyond the agrochemical space to do similar work in the pharmaceutical space, into electrical engineering space, etcetera.

So, this is the sort of core compounders we seem where the earnings itself grow at 15% to 18%. Where we have high degree of productivity and they grow along with that. Where we are identifying new ideas is what I’d call the high growth area. For example, Soma BLW. It’s an auto systems company, but it’s really leveraging on the electric vehicle band wave. So they’re one of the only companies in India which supplies 100% to Tesla, plus have a lot of platforms in Europe and North America. Which is giving a lot of growth width ability. Dixon is a company like Foxconn in India and I mention this outsources which is happening from China. They’re a direct play on that.

The third bucket, which I call positive fundamentals, it’s really where businesses we find where there’s been strong businesses, but there’s some inflection, maybe they had a change in management or the company is really coming off a large capex phase which is now going to drive the growth as well as improve return ratios. Finally, the cyclicals which are really playing the main India growth story. Here, we’re really playing it through our cement companies, our banks and financials, etcetera. In the portfolio, we have fairly low leverage overall in our portfolio.

TOP EARNINGS

A better nutshell of the portfolio. What I’d like to really highlight is the line on top and if you see the earnings growth of the portfolio, it’s really the highest we’ve seen in the decade I’ve been managing this portfolio. There’s a base effect that banks are coming off a low base or cement companies are coming off a low base because of the commodity price increases. The fact is, growth is very high and it’s driven largely, because the economy is doing well. Even on valuations, we are now trading at a 16 multiple. Historically, we’ve been in this range. At peaks we’ve reached a price-to-earnings multiple of 20 times plus, but it’s really come down. In terms of overall exposure, as I mentioned, consumer has always been one of our core themes throughout. Between consumer and financials, I think that’s where our biggest focus is, but I would say every stock in the portfolio, it’s really bottom-up, so it’s very stock driven rather than macro down approach.

Just coming to our performance. I’ve been managing this portfolio for a decade now and in that period, we’ve compounded at almost 13% per annum. We’ve had a good three years. If you see the performance, I think one, two, three-year performance has also been fairly healthy and I believe this 13% compounding, if the earnings play out, the earnings should help compound the portfolio going forward.

IS INDIA EXPENSIVE?

Before I end, I thought I will just address one of the key issues which everyone, all investors I meet, and that’s really that India looks expensive. I thought I’ll just put one or two charts on where India stands. So, this is the price-earnings multiple of the MSCI India index. The fact is that India is today, trading at a slight premium to its historical averages. Unlike what you’ve seen in most other markets. Though the valuations are correcting because earnings are playing catchup, but the fact is, it is at a slight premium to its historical averages.

This is the more interesting chart and which is what worries most investors. This is the performance of the MSCI India index, which is the blue line since 2017 versus the MSCI emerging market index. What’s really happened is while India’s held on, the rest of emerging markets have collapsed, largely led by China. So, while India historically traded at a 30% to 40% premium to emerging markets, this premium actually went up all the way to 80%, 90% and has come down a bit. So, from an investor perspective, from a risk-reward people find that’s why India looks expensive.

Having said I thought why has this happened? This chart really tells you another structural change that has happened in India and the grey line is showing the inflows into the domestic equity mutual fund industry from retail investors. The blue line is showing the flows in the foreign institutional investors into India. What you find is that India’s done well despite huge redemptions from foreign investors. In fact, since January 2022, $21bn has moved out of Indian markets.

So, it’s not that investors have been putting money into India, which is causing India to doing better, it’s largely the domestics. You’re seeing huge flows into equity funds and it’s largely coming from retail investors in very small ticket sizes. The average size is about £25 into the funds. It’s coming through systematic investment plans. Data shows that over the last four years, every month you’ve seen a billion dollars of flows into the equity mutual funds through these systematic investments plans. So, it’s fairly structural I would say, in nature and it’s really reducing a lot of volatility in the Indian equity markets as well.

So, I’ll end with this slide which gives the performance of India versus other global markets on a ten-, 15- and 20-year period. What you’ll find is that India-, the blue lines are India, the large-cap and the mid-cap indexes. India’s actually been a great performer. These are the pound sterling returns over this long-term period. So the markets have actually delivered and they’ve actually kept pace with even the US market, which has had such a strong run. So really, what I’d really like to say is India’s done well in the past and the story is really beginning because all the changes you’ve just seen, the benefits of which are really going to come out from now. So I’ll end with that and take some questions from you, Gavin.

SECOND HALF RECOVERY

GL: Thank you very much, Gaurav. That’s a fascinating overview of the structural advantages India has. I’m going to pick up on a number of those points if I may. I’ll start off looking at the fund, the investment trust, and its performance. It must be about to publish its annual report, it normally comes out in March, maybe April. I was just wondering, the last time we heard in terms of results was at the half year stage. First half of last year was obviously, very difficult with Russia’s invasion of Ukraine and global inflation, but net asset value was up 3.9% last year. So that suggests there was a bit of a second half recovery. Could you just give us an update on how the second half of last year and this year is going?

GN: I think the second half year actually did very well. We went up about 21%-odd on the NAV. I would say that it’s very stock driven, it’s not some sectoral side to it. I think two reasons. One is the fall we saw in the first half fell more because of global macros rather than anything fundamentally wrong with the companies. When things go wrong, you really look at your companies and see, is something going wrong or not? We found that the businesses are doing well, many of them are not even exposed in any way to the global market or the areas where you find stress. So either you just add your weights or you say nothing’s wrong. As the second half came into being, you just realise that it was excessive selling which happened. As the results started coming out and the commentary of the companies, which came out, things were just good ...

[THIRTY MINUTES]

... and the results for some of them have been exceptionally good.

So it was more of a global correction which led to that and they’ve just come back. Fundamentally the businesses are doing well, which is why the whole strategy is look for the longer-term and look for businesses which are inherently strong and the earnings will play out. So, you’ve got to live with this volatility, but be sure you’re buying the right businesses.

ADANI EXPOSURE

GL: I should say, do send in your questions, we’ve had a couple in already, but I’ll be moving on to your questions after mine. So, carrying on with those, at the start of this year saw India stock markets somewhat overshadowed by concerns over Adani Group. That’s the ports, airports, power group that was subject of a very critical report by a short seller. India Capital Growth has never invested in any company in the group, but you’re exposed to banks, what are their exposure to Adani?

GN: The Adani Group has not tick marked a lot of the ESG parameters for a lot of us because you really don’t know what’s going on in the background.

GL: Lack of transparency.

GN: Bit of transparency I would say and our view has always been, if you don’t understand something, don’t waste your time on it because it will always hurt you at some point or the other. The fact is, they have been buying a lot of assets. They own ten listed entities, most of them in the core infrastructure sectors, but the quality of the assets is state-of-the-art. Most of these businesses are not really overly leveraged as well. For example, they’re the largest port operator in India and the largest port, I would rate it as among the top quartile ports anywhere in the world. They have the largest airport operators. They operate the Mumbai airport. Again, a state-of-the-art airport. Most of the bank lending to them, all these assets are really cashflow generated assets, they’re operating assets, they’re not into big investment phase.

So structurally, I think the businesses are sound. Coming to the leveraged side of it and the bank exposure, you’d be surprised that the of the entire loan book, only 25% is with the domestic banks. 75% is with offshore lenders. Here too, it’s all on cashflow based lending. So really, there’s very negligible risk. If you look at the banks themselves, not one bank in the country has more than 1% of their loan book exposed to the group. Hence, I think from a system point of view, there’s absolutely no issue. I think where people are very worried was the stock price ran up, they went up between ten to 30 times over the last three years and most investors had stayed back. They’re very sponsor owned businesses, so liquidity is not as high as well. So, it’s more the stock price had gone up, which corrected, but even today, after the corrections, they’re still at fairly elevate levels. So, from a country perspective, I don’t see there’s much of an issue at all.

GL: From a systemic risk point, that sounds like there isn’t one, but what about a reputational one? Does this play to an old-fashioned, out of date view of India that foreign investors might have?

GN: I wouldn’t think so because I’d say a lot of the reforms have happened. The system per se, is clean. The Adani Group is a known issue and if you speak with some of the leading bankers, etcetera, they all say someone has to build up infrastructure. So, there has been some form of support and my sense is, a lot of the support really comes in getting approvals quicker in those areas. What the assets, when they’ve bid for it, it’s been a competitive bidding. So, it’s not that when an asset has been bought, you’ve been given a sop, it’s more after that. There were other areas which you really don’t know about whether some transactions may happen. I would say there’s a high degree of credibility today on India and the governance that’s happened post these reforms. It’s best reflected that the banks have seen no problem. You’ve had Covid, you’ve had the war and not one large non-performing asset has cropped up.

GL: Speaking of the reforms, could you tell us about the political situation? I think India’s got general elections next year. Is there a risk that Narendra Modi could lose and his reforms could be unwound or are they embedded now?

GN: On his losing I think is a very low probability. He’s a marketing machine and he works really hard and I think there’s no real clear national opposition. So, I would be very surprised if he loses. It’s a question of how many votes he gets, does he again get a majority? I think that’s the big debate. Coming to the reform side, I think in India, it is finally a democracy and once a reform is done, it’s done. It’s very rare you’ll see something being reversed. So even successive governments, they’ve all been reforming. It’s just the pace of reforms this time, have been fairly quick and because you had a majority in the government, you were able to pass on very difficult reforms, which normally have a lot of political backlash. So, once it’s done and the dirty work is done, no one will ever want to go back because finally, it’s very good for the country.

GL: Could you tell us a bit more about India Stack? I knew that a big part of Modi’s reforms were around digitalisation of the economy, but I didn’t actually know about that phrase and about the public utility that seems to be at the heart of this drive to ecommerce. I’m just wondering, is this financial infrastructure, is it boosting the bank profits now? You were highlighting the big increase in credit growth, but you’re saying that was more linked to the economic recovery. Is this infrastructure helping that or is it more about boosting overall economic growth that’s going to benefit everybody, including the banks in time?

GN: It’s basically improved the overall efficiency in the system. I don’t think banks gain out of profitability because as I mentioned, it’s virtually a zero cost. So, banks are linked in there, but they’re doing the volumes of transactions.

GL: They’re small payments. A huge number, but very small.

GN: They’re small payments. So, they’re getting a lot of data. I think it’s giving them a lot of data on consumers they never get data on. So, they now have to really use a lot of intelligence to mine that data, but charges, it’s not there. Having said that, the Stack is creating a lot of efficiencies across the system. I’ll give you an example. Today, the government, all the subsidies it does, it goes straight into bank accounts of the recipients. There’s zero leakage. For example, India subsidises gas for the poorer people. So, you have gas cylinders, if the market price was X, it would be X minus 30, simply because you were subsidising it. Now, you put everything on market price, only all those who need that subsidy, whenever they book a gas cylinder, the subsidy element goes straight into their account.

DIRECT TO THE PEOPLE

[GN cont:] What happens is, this gas was used mostly be the sweetshop owners, restaurant chains, etcetera, because their consumption is large. So now they are paying the market price because there’s no subsidised price itself. So almost 400-plus government subsidy schemes, the money goes straight into bank accounts and the pricing is normal. It’s called a Stack because they’ve done multiple things. For example, I think over 300m poorer people have got an insurance cover, all because of that bank account and the government rolled out an insurance policy on that. Today, they’re trying to do what is called an account aggregator. For example, if I’m a small shop owner, to get a bank loan is very difficult because I don’t have the paperwork. What they’ve done is, they’ve created this account aggregator so you have four, five companies which have been given the license. They can pick all the data from different sources, your bank statement, electricity bill, whatever.

So if I’m a shopkeeper, I just give that agency the authority to aggregate my data and in one snapshot, the bank will have-, whoever’s providing the loan, he’ll have all the paperwork. He can check his daily cash statements from the bank, he can get the electricity bill. He can get everything he has in his shop. So suddenly, the small guy, data was his problem, information was his problem and it’s really opening up the whole system to give credit to the unbanked. So, multiples, I can go on and on for hours on that.

GL: Accelerating growth in financial services.

GN: Exactly so there’s a lot of financial inclusion happening in India.

ENERGY TRANSITION

GL: Sounds like it. You mentioned energy there, the power. I’m just wondering, in terms of the energy transition, I read a very detailed note from Morgan Stanley on the prospects of India, it’s forecasting the kind of growth you were talking about becoming the third biggest economy in the world over the rest of this decade. It said that two-thirds of India’s increased energy needs will come from renewables. So, two questions, are you investing in renewable power providers is the first one?

GN: We’ve looked at them, but we’ve not found the right opportunity.

[FORTY MINUTES]

The fact is, there’s massive investments happening in solar and wind power. I think two things are happening there and from an investment point of view, when it comes to solar, a lot of the capital expenditure is imports. You’re buying all the panels, etcetera, cells, etcetera from China. So, it’s really very much driven on the pricing on that side. On the second side is that the pricing on the front-end also, we are not very comfortable with the arrangements on that. There’s a lot of risk to the business model itself. You can’t play to suppliers there. I think the other issue is also that the biggest players who are going into renewable energy, are your typical coal companies.

So, the traditional power companies who are getting into the renewable space in a big way to de-risk their own model. So, the biggest solar power guys, the wind power guys ware your biggest thermal power companies as well. So really, we’ve not found any really. It’s a good opportunity, but I don’t think we’ve found it interesting enough to play.

GL: Sometimes, the macro ideas aren’t always obvious how to play them, I guess. Your point there brings me on to my second question, which is that there’s two-thirds of this growth in demand coming from renewables and that means the other third is non-renewables. So, is India’s growth still predicated on a lot more fossil fuel consumption?

GN: There will be. I think you cannot hide from the fact that if you have to grow and you have to meet even a 6% GDP growth target, energy consumption has to increase and India, on global parameters is at the lowest end for per capita energy consumption. So, you cannot hide from the fact that thermal power growth will also happen. Having said that, India has committed to being net neutral, carbon neutral by 2070.

GL: That’s quite a bit later than other countries.

GN: I would say China’s at 2060, so yes, we’re a decade behind them. The fact is you’re growing and renewables just cannot grow fast enough to offset it. The fact is the renewable plan, you’re talking about 500 gigawatts of renewable energy coming up the next five, seven years. So that’s the pace at which it’s going, but fact is, energy consumption has to rise in India per capita, so you have to have thermal as well.

INVESTOR FLOWS

GL: I wonder if you could just clarify something for me in terms of the investment flows into India. So, you were highlighting-, is there a distinction to be made between foreign institutional investors and foreign direct investment?  Foreign direct investment in companies like Apple, that they set up a factory in India. So that’s long-standing corporate capital. The foreign institutional investors, that’s more hot money. That’s investors, pension funds, that sort of thing.

GN: Yes, that’s investors like us.

GL: So those have been pulling money out of India, but Indian’s, private investors have been putting more and more money in.

GN: Exactly.

GL: Is that helping the liquidity of the market? Particularly in your area, I’d imagine more thinly traded, medium size, mid-caps.

GN: I would say it’s very stock specific. There are phases when you have very high liquidity and there are phases where liquidity dries up. I don’t think it’s really had so much of an impact, but what we’re seeing is a lot more listings come into place. The IPO [initial public offer] market has exploded a lot. You’re getting about 130-odd companies listing every year. Our intent is, when we buy an illiquid company, our whole idea, in India, liquidity is a function of the price as well. So, our whole idea of liquidity is that you should own a company where, if you need to sell, the business should be so strong that if you’re offering it at 5% discount, there’ll be enough buyers to it. So that’s how we look at liquidity. It may show that it’s thinly traded, but if I want to sell, I can sell it fairly comfortably.

GL: Last question from me because we’re getting a good number of questions in from the audience, which is great. I think there are 34 stocks in the portfolio, according to the latest factsheet. It’s quite concentrated. Are you a high conviction investor or is there actually a shortage of really good companies, despite India’s obvious attractions?

GN: I don’t think there’s a shortage of good companies.

GL: So why have you only got 34?

GN: We go very deep into businesses. We hold them for the long time. So, for us, when we own a company in the portfolio, we should know it better than anyone else. So, our whole aim is, have a portfolio of around 30-odd companies which you’re so confident that you will deliver on that earnings itself. It’s always much more manageable to have a smaller portfolio than have a larger portfolio. There are mid and small-cap funds which are $3bn in size as well, but they’ll have 100-odd companies in the portfolio. Our idea is to be very, very focused, know what we own and have a high conviction on each of our portfolio companies.

CITY VS COUNTRY

GL: Let’s turn to what our audience are interested to know. Let’s start with one of the first ones we received from Elliot Hardy on the payment systems and the digital infrastructure we were talking about earlier. The question is, ‘Despite the new payment system, I was under the impression that there remained large disparities between and urban and rural consumer spends. If so, do you think this is an area for concern or is this a trend that’s expected to change moving forwards?’

GN: I think the biggest challenge in India, that you’ve got to get people gainfully employed. As I mentioned earlier, our per capita income is only $2,300 so there is a huge income disparity. The only way you can address it is to get better paying jobs. The challenge in India is that 45% of our labour force is dependent on agriculture and agriculture’s just 16% of GDP. So, the whole aim is to get manufacturing going. So, you’re having this migration from villages to the cities and it’s all about skilling people, all about getting manufacturing in place and really moving everyone up. So manufacturing is becoming quite key in the whole game.

RUSSIA RELATIONS

GL: Moving onto a more geopolitical topic rather than macroeconomic. A couple of viewers are interested in India’s relationship or alliance with Russia, the Putin regime. So, Lawrence wants to know, ‘Do we think India’s alliance to the Putin regime may have a negative effect on inward investment going forward?’

GN: In this crisis, I think India has played its cards rather well. It’s possibly one of the few countries which has extremely good relationship with the western world, as well with Russia. I think you have to go back a bit in time and the fact is that during the cold war era, the US sided with Pakistan, which we have a very contentious border. So, by default, India has historic relationship with Russia. Today, 60% of our defence, military equipment is all Russian. So you cannot just shy away that you have these historical relations with Russia and Russia’s always stood by you. Having said that, incrementally, if you see the last decade, the relationship between India and the western world has improved dramatically, especially with the US. I think Europe was always very strong, but even with the US. Today, the strategic alliances India has with the US, it’s at a different level.

For example, we formed the ‘Quad’, which is Japan, Australia, US, India alliance to counter China in this part of the world. So, I think India’s played its cards very well and it has very strong relations. Surprisingly, it’s been able to manage this current environment to its advantage. You can just see it, India used to not import Russian oil, but today, we import almost 30% of oil is Russian oil. It’s very much in the open, but none of the western economies is really raising much of a voice because India said, everyone has to meet their own interests and they’ve done a lot of diplomatic negotiation at the backend to still manage in this environment.

GL: Simon Larmer, who’s watching was picking up on that point. ‘What has been the effect of cheap Russian oil?’

GN: India, traditionally, 99% of its oil came from the Middle East, not from Russia, simply because the …

[FIFTY MINUTES]

… transportation costs are very high. So, while you may say it’s cheap oil at the Russian end, at the Indian end, what I understand, it’s about $6 to $7 lower than the price. So, you have about a 10% price advantage on it. So, I don’t think the price is that much of a differentiator which is causing it. I think even the European countries realise it’s a balancing act. If Europe is taking the gas which India was getting from the Middle East, then where does India go. Finally, prices have to come down. So, I’m sure there’s a lot of backroom work happening as to why India’s being able to source that Russian oil.

IS STATE CONTROL A WORRY?

GL: I think you’ve alluded to the China plus one strategy or trend that is seeing more companies setup base in India. So, this comparison with China, Mike King was wanting to ask, “Is there any concern regarding government taking increasing control of successful companies, as we’ve seen in China?”  It seems like a good question because the government’s been so pivotal in some of the changes you’re talking about. Is there a danger of state control?

GN: I think Indians are driving democracy in that sense so it’s very, very difficult for the government to get away with that. When it comes to, yes, if there’s a reason for other aspects. For example, if you’re having a war with a country and then you acquire assets, it may be different. I would say it’s very difficult. I think the whole idea of the reforms was to try and make things as transparent as possible and minimise the role of government in approving things. So, I don’t see that as a big risk in India. It can happen, but I think the economic environment in India and China are poles apart I would say. It’s a very, very different market. India’s a lot more market driven economy I would say. On the other hand, in fact, the government’s really been trying to get out of businesses, frankly and leave the business bit to the corporate sector.

SOCIAL TENSIONS

GL: You referred to historic tensions between India and Pakistan, Vivienne Woodall is wondering about internally. ‘So, when Modi first came to power,’ she says, ‘there were concerns about tensions between ethnic religious groups. Has this risk now disappeared?’ 

GN: No, it has not. In fact, the biggest weakness of Modi may be in this aspect. That he’s viewed by some sections of the society, that he is very Hindu-focused and anti-one or two communities in the minority side. If you see the press and even the international press, it’s very anti-Modi for that reason. Even within India, there are very divergent opinions on Modi. Some love him, some hate him. If there’s any aspect which can cause his downfall, it’ll be this aspect. The fact is, people are a bit scared. You speak with the media, they sometimes get scared that if you speak out on this issue, you’ll be targeted, but I think this is an issue and it is a fact that people are worried that it’s becoming too much of a one religion country and that’s where the focus of the government is.

ONLY MID CAPS?

GL: Thanks for all your questions, do keep them coming in. Focusing a bit more on the fund. Simple question one from Koshal. ‘Does the fund only focus on small and mid-caps or do you consider large-caps, large companies as well?’

GN: No, I think the idea is that any stock we buy should be a small and mid-cap. We have about 8% to 10% in large-caps, but these were small and mid-caps which over time have compounded and become large-caps.

GL: You don’t feel obliged to sell them when they become large?

GN: If the story’s still good, why sell it? The idea is that we find huge opportunity in the small and mid-cap space. There’s no shortage of ideas. It’s really about how much work you can do on any one business. Even the new listings, we’ve had quite a few of new entrants, companies which have IPO’d in the last two, three years. Very high-quality businesses. What I’d really like to emphasise is, when I say small and mid-caps, if you really see our portfolio, most of the stocks are either leaders in their industry or they’re dominant in the industry or they’re such niches that there are very strong entry barriers. So maybe we call them small and mid-cap, but from our perspective, they’re actually dominant leading players. The whole idea is, these small and mid-caps become large-caps of the future.

GL: Charles wanted to know, ‘What is the average yield across the portfolio investments?’ It’s a growth fund, isn’t it, but is there some income coming off it?

GN: The yield is low, it’s about 1.5%. The reason is it’s not that the businesses are not generating a lot of cash and paying out huge amounts of dividends, it’s just that it gets captured in the price as well. So, your market cap-, I would say, the Indian market yield itself, is about 1.5%. So, it’s just to do with the fact that you have some very good, high-quality, strong cashflow generating businesses, but there’s a price for it. So, the yield just adjusts down to 1%, 1.5%.

GL: The fund pays dividends regularly?

GN: The fund does not pay dividends. We reinvest it. We see enough opportunities for that.

INDIAN GOOGLE

GL: A question here, ‘What is the chance of an Indian Google or Tencent emerging?’ Is there a chance of a mega-cap emerging?

GN: Certainly. If you see, India’s got a thriving digital ecosystem. I think after the US and China, India’s the third largest digital startup ecosystem. There’s some very, very innovative business models which have come up. I think the last two years is the first time you saw some of them go in the public market. So you had eight to nine of them now in the listed space as well. I wouldn’t be surprised if India sees a mega-cap come up very soon from India. It’s a thriving ecosystem. The city of Bangalore in India is called the Silicon Valley of India. It’s just full of VC [venture capital] investors and it’s also the startup hub of India. So, watch this space.

WHAT ARE YOUR CHARGES?

GL: Going back to the fund, ‘What are your charges and how do you justify them?’ That’s Vivienne Woodall again.

GN: Our fee structure is about 1.25% but it’s on the market-cap. So, we’re aligned with the investors. So effectively it works at about 1% is the management fee.

GL: So, on the share price, rather than the net value. So, if shares are trading at a discount below the value of the fund, you’re earning less.

GN: Yes. So, my job is to try and ensure that the discount is the minimum by performance.

GL: The trust’s shares, actually, talking about that, are trading at around a 12% discount at the moment and there’s a second redemption point at 3% discount at the end of the year. That just now, could be a good entry point would you say?

GN: India’s always a good entry point, but I think you should play India for the long-term. I think, never look at India from a trade. I see it as a very strong ten-year story and as you’ve seen even the last ten years, we’ve compounded at 13% in sterling, despite all the reforms and the hits it took. I would believe that this is a story which will playout for much, much longer. So yes, get into India, but look at India from a much longer-team.

WHAT WOULD FALL OF MODI MEAN?

GL: Last one here from Mike King, ‘In the event of the fall of Modi,’ he writes, ‘what would be the likely direction of travel regarding the investment environment?’

GN: It will not change and I’ll tell you why. Today, Indian elections are fought on development. If you go to India, there are six, seven leading states who are competing with each other on all the foreign direct investments coming in. Largely because today, every politician has realised that the way you can get votes is by giving them jobs. So, you see the business newspapers, you’ll have frontpage ads of state government saying, we are ranked so high on ease of business, we can give you land. It’s a plug and play model, you come in, all approvals given. So, the whole story of India has moved out of religion and caste-based politics to development-based politics. So, it’s a very, very dramatic change which has happened in the last six, seven years in India. That it’s really all about what can we do for the people and people have also realised that. They vote now, on what’s benefiting them in terms of jobs, etcetera, rather than getting a few cash goodies here and there. It’s a very changed environment and you have to come to India to see the vibrancy that is there and how it’s all about development now.

GL: Last question, because we’re nearly out of time. I started with mentioning the sale of Ocean Dial to AssetCo. That transaction doesn’t change the investment trust’s relationship with you as the portfolio adviser, but I’m wondering, what are you hoping for from a UK-based owner rather than an Indian one.

GN: We had a very good Indian owner and a very professionally run business, but I think the difference was that their core business was i-banking. What we get now is focused asset management. So, I think we can leverage a lot on their resources. Both on the sales and distribution side, as well as try and pick up their investment strategy and see if we can really find tools which we can utilise at our end. So, it’s more about leveraging the resources because it’s a very, very focused asset management company out here.

GL: Wish you all the best with that.

GN: Lots to look forward to.

GL: Gaurav, that’s all we’ve got time for I’m afraid. Thank you very much for coming to spend time with and for answering all our questions. Thank you, everybody out there for all your questions that you’ve sent in, that’s been great. I hope what you’ve heard as whetted your appetite for investing in India.