Destination India

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Financial planners have traditionally gained exposure to emerging market economies for their clients via global equity funds or through discrete emerging market funds. Lonsec has noted a significant trend in global equity fund managers increasing their scope to invest in emerging market economies as part of their mandates.

Another trend has been the proliferation of single country emerging market funds. While much of the discussion concerning emerging markets focuses on China, other emerging markets have also experienced significant growth; this article puts the spotlight on the largest democracy in the world, India.

Indian economy
India has recently emerged as a vibrant, free-market democracy after the economic reforms of 1991, and it has begun to flex its muscle in the global information economy.

With an average GDP growth rate of 8% for the last four years, India is one of the fastest growing economies in the Asia Pacific region and, according to the International Monetary Fund, is also the fourth largest economy in the world in terms of Purchasing Power Parity (PPP). Measured in Australian dollars, it is the eleventh largest with a GDP of $1.40 trillion in 2010. Growth has primarily been driven by robust performance of the manufacturing sector on the back of government and consumer spending.

As the economy grows by some 9% a year, India faces challenges to sustain this economic growth. In late December 2010, the commerce ministry judged that food inflation has reached 18.3%, with expensive vegetables mostly to blame. For example, the price of onions doubled within half a year due to unseasonal rain during harvesting season. While the price of onions has now dropped by 60%, food inflation remains sticky at elevated levels. The broader inflation rate is a less eye-watering problem and is currently around 9%.

Inflation may remain elevated despite the current anti-inflationary monetary stance. The Reserve Bank of India is very determined to anchor inflation having raised the interest rates ten times since March 2010 as growth recovered.

Infrastructure
The building of the Taj Mahal is a good metaphor for the work that lies ahead if India is to realise its potential as a global economic power. The Taj Mahal took 22 years and 22,000 workers to build under the guidance of an imperial Mughal ruler in memory of his widow.
Growth in India is best described as ‘the potholed road to prosperity’.

Persistent migration to the cities is putting tremendous pressure on existing infrastructure. In a traffic system that’s so helplessly overloaded, it takes a true miracle for things to work. Public transport is in disarray, with many of the country’s dynamic entrepreneurs wasting hours each day stuck in traffic. Firms are hobbled with the cost of building their own infrastructure, such as a fleet of buses to ferry staff to work. Aside from supply disruption, bottlenecks in infrastructure and distribution lead to inflation; for example, 40% of fresh food is rots before making its final destination.

In a positive sign that roadblocks and inefficiencies are being dealt with, the Indian Government has constituted a committee, headed by the Prime Minister, to get core national infrastructure projects underway.  The committee plans to spend US$1 trillion (8.4% of GDP) annually on infrastructure under a five-year plan, due to start in 2012, compared with a US$542 billion (7.5% of GDP) in 2010.

Performance
Foreign institutional investors (FII) play an important role in Indian securities markets. The number of registered FIIs went up to 1,713 by the end of March 2010, from 1,635 the previous year; equity transactions were worth A$22.75 billion in 2009-10 against A$10.1 billion in 2008-09.

Performance is closely linked to the global and local economic performance as was demonstrated when Indian equity markets rose on the back of strong domestic economic performance and inflows from Foreign Institutional Investors (FII) funds. The buoyant economic outlook helped the Indian stockmarket attract more than A$24.5 billion in net flows from FIIs, insurance companies and fund managers in 2010, an increase of 65% from the previous year.

Like most major equity markets, 2009 saw the Indian stock market in recovery mode followed by a period of consolidation in 2010. The Indian market (measured by MSCI India) returned 14.74% for calendar 2010, compared to the MSCI China at 2.59% and MSCI World 9.55% for the same period.

How to invest in India
India may be considered as an investment option for Australasian investors, however it has taken a back seat to China and the result is generally a very small allocation in most portfolios.

For financial advisers who have considered the pros and cons of an allocation to the Indian growth story, the following investment options are some of those available:

  • India Specialist Funds* – examples include Fidelity India Fund and Fiducian India Fund – 100% exposure to India
  • Global Emerging Market Funds – examples include Aberdeen Emerging Markets Fund, Schroders Global Emerging Markets Fund and Templeton Emerging Markets Fund –  typically up to 20% allocated to India
  • ETFs or Index Funds – iShare or SPDR over MSCI BRIC Index, MSCI Emerging Markets Index, MSCI AC World Index
  • Global Equity Funds – Fidelity Global Equities Fund, T Rowe Price Global Equity Fund, Templeton Global Trust Fund, Walter Scott Global Equity Fund – typically less than 1% allocation to India
  • ASX-listed companies – some Australian resource companies, including coal and iron-ore companies, with high percentage export to India

* These are among the Funds research by Lonsec, with research reports available to subscribers.
Note: Foreign nationals are not allowed to invest directly in Indian debt and property markets.

As discussed in its 2011 Global Emerging Markets and Regional Equities Sector Review, Lonsec believes there are a few rule of thumb checklists for investing in emerging markets that can be considered.

Firstly, investors seeking exposure to global equities should primarily invest in well diversified global equities funds able to take advantage of mispricing opportunities across stocks and regions. Advisers should also be mindful of monitoring and maintaining a balance on the overall exposure to developing economies within their clients’ global equities allocation. On a look-through basis, it is possible that existing broader global equity fund holdings are already providing meaningful emerging markets exposure (e.g. 10 – 20%).

Secondly, Lonsec believes there is a compelling case for including emerging markets within a blended global equities allocation however, recommends allocations to stand alone emerging markets / regional equities funds only be made to augment broader global equities exposure dependent on client risk tolerance.  Lonsec believes a (10-20%) allocation to emerging markets from the overall global equities allocation may be appropriate for certain clients.

Thirdly, Lonsec recognises that India is a significant growth market and there is a broad spectrum of investment opportunity for advisers seeking to give clients exposure to the economy (eg. single country funds, regional funds, emerging markets / BRIC funds).  Lonsec believes a broader Asia ex-Japan mandate is an attractive initial mechanism for gaining exposure to the Indian region and, in theory at least, allows investment managers the flexibility to position the portfolio in favour or against India depending on the relative strength of their conviction in Indian stocks.  However, those clients wishing to gain a deeper exposure to the India theme may prefer a single country approach.

There is some evidence that specialist emerging markets managers with dedicated resourcing and tailored investment approaches may deliver superior performance outcomes in emerging markets versus those global equities managers primarily centred on traditional developed markets. Lonsec‘s higher rated managers will tend to be singularly focused on this asset class, with dedicated resources either on the ground or with frequent company visitation programs as opposed to a bolt on approach to another strategy.

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