What Next for Indian Equities?

Economic growth and company profits have tended to be strongly correlated in India over the past 25 years. But in the past five years, coinciding with Modi’s election in 2014, earnings have lagged the rise in GDP. While share prices have been soaring in recent months, with the Nifty 50 and BSE Sensex reaching new records, profits have struggled to keep pace.

“We’ve had zero earnings growth in India now for five years for the top 30 companies,” Shroff says. Somewhat counter-intuitively, whiel some of Modi's reforms have had a signficant and positive impact - the crackdown on counterfeit money, for example - they have dragged on growth in the short-term. 

The Goods and Services Tax, for another example, was previously decided locally but has now been standardised across the country. While this will be positive in the long-run, it has disrupted many companies and hit profits in the short-term.

Kaustubh Belapurkar, a Morningstar analyst based in India, says that many of Modi’s reforms have yet to bear fruit. But now Modi's re-election offers the opportunity for the Prime Minister to implement his 10-year plan.

Both corporate and government spending are starting to ramp up again now that the election uncertainty has gone away, and “investors are going to return in a huge way”, predict Belapurkar.

The JPMorgan India trust has a Bronze Rating from Morningstar analysts, who rate the partnership of managers Rukhshad Shroff and co-manager Rajendra Nair, who bring “a level of continuity that few can match in this space”.

“The process has been in place and refined over a number of years, emphasising buying companies that can deliver superior earnings growth over long periods of time,” says Morningstar analyst Jan Nel.

The trust is a concentrated, conviction-based portfolio of around 30 names that has historically favoured financials. It currently trades at a discount of around 11% to its net asset value (NAV) and has assets of more than £900 million under management. Nel notes the board’s commitment to managing this discount, buying back shares and offering shares under tender to investors if the fund underperforms the benchmark.

Overweight on Banks

Among the fund’s five biggest “overweights” - where it has a bigger stake than the MSCI India index - there are three banks, including HDFC (HDFC), which makes up 9.2% of the portfolio. Shroff says that banks have struggled in recent years but have started to clean up their act after pressure from the government to reform.

Shroff thinks HDFC can continue to outperform as it holds a small but significant part of the nascent Indian banking market, which is still dominated by public sector banks. An initiative to create a digital ID for every citizen has brought millions of people into banking, he adds.

The trust has outperformed MSCI India for the 15 years to the end of June 2018. In 2018 as a whole, it underperformed the benchmark – JPMorgan India’s share price fell 8%, while MSCI India dropped 5.7% - but it is ahead of the benchmark in the year to the end of May, and was one of the best performing closed-end funds in May with a gain of 6.8% - helped by the election euphoria.

Schroff says the trust’s performance can vary from the benchmark, which is dominated by certain stocks. Oil and gas producer Reliance Industries (RELIANCE) is the biggest stock in the MSCI India index, but is not held by JPMorgan India. Reliance’s share price is up from 541 rupees at the start of 2017 to 1,299 today, a gain of 140%. The trust doesn’t hold Infosys either, which makes up 7.7% of the benchmark.

Among other high-performing India open-ended funds in May, Bronze-rated Fidelity India Focus gained 7% in the month. Franklin India, which has a Morningstar Analyst Rating of Silver, rose more than 5%.

High Valuations a Concern

"Even if you take the view that Modi will continue to over-promise and under-deliver on inflated expectations during his second term, the fundamentals are still compelling," says Jason Hollands, managing director of Tilney.

India is the fastest growing economy in the world, with an increasing cohort of young workers. The Indian economy is also less dependent on world trade than China, which has struggled in the face of US tariffs. 

But Hollands cautions that high valuations and rising oil prices are still headwinds for those expecting the next leg of the Modi bounce. As a net importer of energy, Indian is vulnerable to rises in the oil price. The price of crude jumped recently as tension between the US and Iran escalated. 

But at the moment, India's inflation is relatively low in emerging market terms. At 3%, this is similar to that of developed company, compared with, say, Turkey's 18.7% inflation and Argentina's 57%.

There are also concerns over youth unemployment and the relatively low participation of women in the workforce. Recent consumer spending figures have shown a slowdown in car sales as well as a softening in wage growth, particurarly in rural areas, where drought has has hit crop production.

The MSCI Emerging Markets index has a weighting of just above 9% for India, with only South Korea (12%), Taiwan (11%) and China (31%) above this. There are a number of managers who have less exposure than this to India.

Among closed-end funds, Schroder Asian Total Return (ATR) has a weighting of 5% towards India. The trust scores the highest rating awarded by Morningstar: it has a five-star rating and an Analyst Rating of Gold. Neutral-rated Templeton Emerging Markets (TEMIT) has a 7% weighting towards India, below the benchmark, but the managers are still keen on one of its banks, ICICI (ICICIBANK), which makes up 3.52% of the trust's portfolio.

India is not often seen as a happy hunting ground for income investors. So it is not surprising that four-star rated Jupiter Asian Income, which yields nearly 4%, does not hold any Indian equities in its 30-stock portfolio.