QD view – Hot stuff

Forget the Magnificent Seven, the Indian stock market has been the unsung hero of the past decade. The MSCI India has delivered an annualised return of 13.6%[1], that puts it ahead of the MSCI World (9.97%) and its emerging market peers (3.33%). The returns from the country’s small-and mid-cap sector have been even higher. With the country likely to return reformer Narendra Modi as Prime Minister in this week’s election, it remains on course to steal China’s crown as the most important emerging market.

For the time being, there is little to disrupt the country’s astonishing growth trajectory. The return of Modi will cement the country’s reputation for political stability and ensure continued financial reform. The IMF recently revised its 2024 GDP forecast higher, and is now predicting that the Indian economy will expand 6.8% in 2024 and 6.5% in 2025, reflecting “continuing strength in domestic demand and a rising working-age population”[2].

Gaurav Narain, adviser to the India Capital Growth Fund, says: “The economy is firing on all cylinders. Virtually every sector has a story.” He attributes this strength to Modi’s structural reforms since 2014, which have seen the banking sector transformed, the real estate sector strengthened, infrastructure improved and technology employed for greater efficiency. A uniform tax system across India’s 29 states has helped removing complexity and encourage trade.

While this has not been without its pain points, Modi’s programme of reforms has created fertile conditions for growth. Government finances are healthy. Rather than embarking on vast fiscal programmes, the government took a calibrated approach to the pandemic, which has left it in a better position. Narain adds: “This means they can continue to think big for the next 5-10 years. There is so much growth momentum.”

India has other factors in its favour: it has one of the best demographic profiles in the world, with a vast working population (around 680m[3]) supporting a relatively small old age population (7%[4]). A Goldman Sachs report “The rise of ‘Affluent India” shows that India’s cohort of affluent consumers will increase from around 60 million in 2023 to 100 million people by 2027[5].

A relatively low per capita GDP – $2,730[6] – gives it a strong pipeline of growth as it plays catch up. For comparison, China’s GDP per capita is now $13,140. Equally, the government has been active in encouraging international businesses looking to diversify from China to invest there through its ‘PLI’ (Production Linked Incentives scheme). This is drawing manufacturing to the region: India’s iPhone output, for example, has now hit $14bn[7].

The problem for investors looking to participate in this growth is that much of it is already reflected in stock market pricing. The forward P/E of the MSCI India is 22.1x, compared to the 12.1x for the wider MSCI Emerging Markets at 12.1x. India also looks expensive on other measures – 4.1x on price to book, compared to 1.7x for wider emerging markets. The small-and mid-cap sector had an abrupt sell off in mid-March after the financial regulator warned of froth in the market[8]. There has also been some broader weakness over the very short-term, with the AIC India sector trailing the AIC China sector by around 14% over the past month.

Does this argue for caution from investors on Indian investment trusts? Ayush Abhijeet, investment director at White Oak Capital Partners which manages the Ashoka India Equity Investment Trust, says the strength of the Indian stock market has been remarkably persistent over time: “It is the second-best performing stock market over 30 years, and it has tended to grow in line with nominal growth – around 11-12% in local currency terms. So, the best time to invest was 30 years ago, and the second-best time is now.”

He points out that India has always traded at a premium to broader emerging markets, and deservedly so. It has better governance, he says, plus stable politics and a marked absence of the currency and economic crises that have hurt some of its peers. It has a strong system of property rights, plus improving infrastructure. “This is why it gets higher multiples,” he says.

Plus, he says, “many emerging market countries, even Taiwan or Korea, have a single engine of growth. In India, there is no single industry that dominates the market. The quality of the growth is very heterogeneous.” This diversity is reflected in the stock market, which is not dominated by a single sector, and where a strong pipeline of IPO activity continues to refresh the market.

However, even enthusiasts for the region are cautious. James Thom, a senior investment director on Asian and Indian equity strategies at abrdn, says he would like to have more in India, but is deterred by high valuations. “Investors need a longer timeline to make India work. Valuations are pretty full and we have seen the repercussions in the small-and mid-cap sector, which got a little frothy and then sold off.” He says there are risks. For example, labour participation rates are relatively low, and job creation will be vital to harness India’s demographic dividend and avoid social issues.

He says there are areas that have been left behind in the general market excitement and this is where he is focusing. Thom cites areas such as real estate and some of the capital goods companies. He adds: “There has also been a big push on public sector capital expenditure. Private sector capital spending is only just starting to emerge, and this should be a multi-year story.” He believes political stability is helping give businesses confidence to invest. “We’ve been playing this through the capital goods companies. These are the companies that provide, for example, machinery and infrastructure components. Data centres are another important area.”

Abhijeet is focusing on five growth areas: financial services, consumer discretionary, healthcare, technology services and industrials as long-term winners in India. The Ashoka India Equity Investment Trust holds 40% in large cap, and the remainder small-and mid-cap [9]. Narain on the India Capital Growth trust also has significant holdings in financials and consumer discretionary stocks. He remains predominantly focused on small-and mid-cap companies with just 7% of the portfolio in large cap[10].

If investors decide to take a risk on short-term volatility in pursuit of the longer-term growth prospects for India, there is an argument that investment trusts are a better way to invest. The abrdn and JP Morgan trusts remain at near-20% discounts, while the Indian Capital Growth Fund is at 9%[11]. Discounts have always been relatively high, but there is no reason why this should be the case in future. If liquidity returns to the investment trust market more generally, these discounts in a high growth area such as India may seem anomalous. Investment trusts could be a way to access an expensive market at lower cost.

[1] https://www.msci.com/documents/10199/1ad792ce-3199-445c-8be3-f2a035ac78…

[2] https://www.imf.org/en/Publications/WEO/Issues/2024/04/16/world-economic-outlook-april-2024?cid=ca-com-compd-pubs_belt

[3] https://www.spglobal.com/en/research-insights/featured/special-editoria…

[4] https://www.pewresearch.org/short-reads/2023/02/09/key-facts-as-india-s…

[5] https://www.goldmansachs.com/intelligence/pages/indias-affluent-populat…

[6] https://www.imf.org/external/datamapper/NGDPDPC@WEO/IND/BGD

[7] https://www.bloomberg.com/news/articles/2024-04-10/apple-s-india-iphone…

[8] https://www.reuters.com/markets/asia/india-markets-regulator-flags-frot…

[9] https://ashokaindiaequity.com/portfolio/

[10] https://www.indiacapitalgrowth.com/portfolio/portfolio-holdings/

[11] https://quoteddata.com/sector/investment-companies/asia/india/

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