Is the party just getting started in India?

20th October 2016 by Darius McDermott

I heard it phrased recently that “the party has barely started” in India. With annual Diwali festivities taking place next week, this might have been the topic of conversation. Given I was chatting with a group of fund managers though, I’m inclined to think they were referring to the Indian economy.

There are good reasons to celebrate. In line with the Diwali values of light, hope and renewal, India has shown signs of regeneration over the past couple of years, since Narendra Modi came to power, that seem now to be truly coming to fruition.

For example, the country’s upper house of parliament recently passed a historic goods and services tax bill, which will replace a plethora of central, state, interstate and local taxes. The efficiency gains for business owners are expected to be huge, not to mention the streamlining of revenue from a government perspective.

Another big achievement has been the Reserve Bank of India’s inflation targeting. The rate of inflation—meaning how quickly prices rise—has long been volatile in India. Rapid price growth, which has been the problem in recent years, erodes consumer spending power as wages rarely grow apace, so it makes sustainable long-term growth difficult. Last year, India’s central bank and government agreed to a formal inflation target rate of around 4%, meaning there is now a commitment to using monetary policy tools like interest rates to try to keep inflation under control.

What’s more, several of the factors that impact Indian inflation are moving favourably to bring down the rate at the moment. The first successful monsoon for three years and good rainfall across the country has led to strong agricultural production. The government has begun a raft of infrastructure projects including road building, an area where India has been notably lacking in the past, with difficulties transporting food often contributing to price rises. India is also a major energy importer, which means its costs have fallen in line with the oil price over the past couple of years.

As an overlay to all of this, there are the oft-heralded demographic virtues. Sixty-five per cent of Indians are under 35 years of age, which puts it in a rather select group of economies with an expanding working-age population. This is creating a burgeoning young middle class, estimated to be nearly 600 million strong by 20211.

Before we don our dancing shoes, however, I do like to mention a few provisos when I’m talking about India. The first is value. The Indian market does always trade at a premium, normally because it tends to have a better return on invested capital than other markets. And it’s trading a little ahead of its long-term average, so it doesn’t look cheap today. However, as funds managers from almost all sectors will tell you at the moment, it’s hard to find good growth stories. It may be that we simply have to “pay up”, as the lingo goes, for the potential to earn better returns.

Additionally, it’s important to remember that it is a developing country, where regulations and red tape can readily impede progress. Much work on employment, infrastructure and health care remains to enable India to achieve its grandiose growth predictions. Its stock market will be far more volatile than, say, the UK market and currency movements will also impact UK investors’ returns.  A falling pound, while boosting returns made overseas when converted back into sterling, does sadly make the equities more expensive to buy initially. India is my favourite emerging market, but I would definitely be looking at the region as a long-term investment to ride out these sorts of ups and downs.

Two Elite Rated funds give investors the opportunity to access different themes. Goldman Sachs India Equity Portfolio, with lead manager Prashant Khemka and his team based on the ground in India and Singapore, has a very consistent track record of outperforming its benchmark. One of their real strengths is the number of company meetings they undertake, which mean they build an in-depth awareness of what’s happening across the whole of the economy. When it comes to buying stocks, however, they are disciplined and apply a solid process, only investing where they see an opportunity for substantial gains.

A second fund is Ashburton India Equity Opportunities. A distinguishing feature is that it holds only around 20 to 30 stocks. Such a small portfolio can increase risk, but the managers make sure they invest in a range of industries, which provides diversification. And we like the concentrated nature of the fund, as it also enhances the potential for returns if the companies do well. The managers believe the strongest growth prospects are among smaller Indian companies, so they look for opportunities outside the index, as well as holding some larger stocks.

Much like getting the right guests to your party, India has many of the right macro economic elements brewing to really kick things off at the moment, supporting its entrepreneurial culture. Whether it will be a night to remember remains to be seen.

1Future of India, Pricewaterhouse Coopers report, November 2014

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.