Kunal Desai recently celebrated his third anniversary as manager of the Neptune India Fund. Kunal has built a strong track record of outperformance since he assumed responsibility for the Fund, delivering a return of 30.3% compared to the MSCI India Index gain of just 14.0%.*
*Source: Lipper, as at 31 December 2015. C Accumulation share class performance, in pound sterling, with net income reinvested and no initial charges. The performance of other share classes may differ.
After 2014’s stellar gains, India has continued to outperform its emerging market peers, but absolute returns have been lacklustre. Under the reform-minded government of Narendra Modi, what will it take for India to become a shining light in a global context?
Despite considerably outperforming the wider MSCI Emerging Markets Index since the end of 2012, Indian equities have lagged the developed market-centred MSCI World Index. The election of the reform-minded Narendra Modi in May 2014 was hailed as a bright spot for the Indian stockmarket and the Index subsequently enjoyed a stellar year. However, investors have since grown weary of what they perceive as the government dragging its heels, most notably a frustration at a lack of ability to force through big ticket reforms, such as those surrounding land acquisition.
Relative performance of Indian equities since December 2012
Source: Lipper, as at 22 January 2016. Past performance is not a guide to future performance.
The signs are positive, but something else is needed
India’s macro indicators remain strong, with GDP growth above 7%, falling twin deficits, a low oil price, improving FX reserves and falling inflation. However, to move from a GEM relative return story to an absolute return story requires something more. We believe that an earnings upgrade cycle, kick-starting a fresh investment cycle, will be pivotal if India is to move to an absolute return story.
We remain optimistic about this for a few reasons. Asset utilisation is at a low of 72% and demand is now picking up in a few areas. Furthermore, corporates are still remaining conservative with regards to their capital expenditure budgets. The combination of these three factors presents a fertile environment for return-on-equity (ROE) improvement and rising return ratios. As return ratios exceed the cost of capital, so companies are incentivised to increase capex to capture the promise of future growth, thereby triggering the aforementioned investment cycle.
In our view, it is the continuation of micro-reforms that matter most for India at the moment, given the discord that was a legacy of the previous administration.
Government reform: the detail is in the micro, not the macro
No timeline was given by the government for its big ticket legislative reforms, which are naturally the ones that excite global investors most. However, in our view, it is the continuation of micro-reforms that matter most for India at the moment, given the discord that was a legacy of the previous administration. For example, on a recent research trip, IndusInd Bank spoke of the extent to which administrative reforms had already laid the foundations for accelerating growth and now required no parliamentary approval. Elsewhere, clean and transparent coal and spectrum auctions have laid the platform for future resource allocation, and foreign direct investment (FDI) regulations have been relaxed across sectors. In short, we believe that expectations have to reset to react positively to incremental newsflow. Global investors avoiding these details should understand the merits of these micro-reforms in the future, once their impact on earnings crystallises.
The earnings & growth story
Despite these recent concerns, India is still the fastest growing major market in the world, with estimates for GDP growth in FY 2016, 2017 and 2018 currently standing at 7.35%, 7.40% and 7.90%, respectively.
However, private sector capex appears to have been absent of late, due to companies having over-leveraged balance sheets and being in a period of capex restraint, and it is this which has triggered concerns around growth. Nevertheless, the public sector has picked up the reins and is helping to stimulate economic expansion, with increased participation particularly evident in road and rail investment. It is also worth noting that there are green shoots emerging: car sales have grown 22% year-on-year (YoY); commercial vehicles sales have grown 12.7%; oil demand has risen 15%; air traffic is 18.8% higher; and power demand has increased 6%.
Economic indicators are showing expansion
Source: Bloomberg & Neptune Research, November 2015.