Where is India heading?
The picture looks rosy for India's economy - its GDP growth rate has averaged over 7% over the past three years and expectations for future growth are even higher. At last year's Economic Summit, the Prime Minister suggested India should target 10% growth on the back of higher agricultural output and infrastructure upgrades. Nevertheless, the challenges for the country remain significant; not least its woefully inadequate infrastructure and the fact the agricultural sector accounts for two-thirds of the population yet generates only 25% of GDP.
Despite agriculture's relatively small percentage of GDP, it is expected to enjoy significant productivity gains as India's road network and infrastructure develops. This will allow farm output to be more efficiently brought to the market; at present, only around 60% of farm produce reaches the consumer. Introducing greater efficiency in the supply chain and retailing of farm output will translate into lower prices for consumers and higher revenues for farmers, boosting rural consumption.
Both manufacturing and services have become major driving forces for the Indian economy; manufacturing growth was 9.4% in 2005-06, and construction growth has been in double digits for the past three years. India's merchandise exports have recorded annual growth rates of over 20% since 2002-03 and software service exports have grown by over 30% over the past few years. India is the world's second largest producer of food after China, and total processed food production in India is likely to double over the next 10 years.
Air travel is another big area of expansion - here India's growth rate outstrips China's; while the number of flights to and from China and domestic flights in China are up 5% and 15%, respectively, over the past year, the equivalent numbers in India are 19% and 49%. This compares with five-year growth of 65% for China and 84% for India. The belief is the Indian airline sector will expand by around 25% annually for the next five years. India's low-fare carriers forecast that 350m middle-class Indians will fly rather than travel by train.
The consensus among the equity fund managers we speak to is that there are no real threats to the Indian economy as the current momentum is so strong. This is supported by strong jobs and wages growth, particularly in the IT sector where employment is expected to double within 10 years. Other drivers are strongly rising consumption and massive spending on capex, which is on a completely different scale to anything seen before. One fund manager notes that each of the government's four to five power projects currently underway will add 0.5%-1% to GDP. Saying that, there are several challenges facing the country, such as the prospect of rising interest rates which will moderate industrial growth; a need for fiscal reform in order to bring more Indians into the tax net - at present less than 7% of India's labour force is in the formal economy, and only 35m people pay income tax.
Other issues are India's agricultural dependence on the monsoon - more areas need to be brought under irrigation with better water management; the country's poor infrastructure; the need for a better spread of education; and, lastly, procedures and entry barriers for foreign companies need to be relaxed.
Looking at the Indian equity market, global emerging market managers feel India looks expensive versus other emerging and developed markets on a forward P/E of around 17x.
However, the dedicated Indian managers remain fairly comfortable with valuations at around the 11,000 level on the premise that earnings growth remains reasonable and many companies offer decent dividend yields. Their view is the main risks to the market are external in terms of geopolitics and further monetary tightening in the US, arguing these would lead to lower investor risk appetite and a flight to quality.
Although fund managers see some short-term market volatility persisting until there is greater clarity on US rates, the consensus remains extremely positive on the medium to long-term story for Indian equities. This is on the premise that massive spending on capex and infrastructure will lead to improved productivity and efficiency, and rising jobs and wages growth will boost domestic consumption, particularly in the retail, real estate and travel sectors. What seems clear is that the positive changes currently under way in India make the market an attractive medium to long-term destination for investment.
Highly Rated Funds:
HDFC Equity Fund - onshore The investment approach is a blend of top-down and bottom-up analysis. The manager follows a disciplined investment process, selecting stocks from the group's core list of stocks that comprises approximately 200 high quality and sustainable businesses that are well understood by the team. Two-thirds to three-quarters of the portfolio is in liquid names with the remainder in less liquid small and mid-cap names.
The manager's focus is on the market position of a company rather than its market capitalisation; 90% of the portfolio is in companies which are amongst the top three in each industry in terms of market share. His focus is very much on quality rather than momentum and management credibility is critical.
Key attributes of fund and management team:
■ Solid track record - consistent relative performance
■ Well-resourced and high quality team led by the group's CIO, Prashant Jain
■ High quality research-based investment process
■ Disciplined risk controls for the purposes of portfolio construction
DSP Merrill Lynch Opportunities Fund -
onshore While the investment approach is
primarily bottom-up, it also includes top-down analysis of sectors and themes. The aim is to identify growth sectors and companies that can deliver supranormal growth within these sectors with a focus on quality. The manager favours companies with a competitive edge versus their peers and companies with high ROEs that make efficient use of their capital. The culture of the team is that it contains a wide set of skills which results in healthy cross-fertilisation. The team members are generalists, citing their competencies as valuation and portfolio construction and weakness as the relatively small size of the team, which means they also use carefully selected external sector analysts. Since December 2005, the fund has been managed by Soumendra Nath Lahiri, who joined the group in June 2004, upon the launch of the group's TIGER Fund, which he has managed since launch.
Key attributes of the fund and the management team:
■ Solid performance track record
■ High quality, highly motivated and well-integrated team led by the group's president and CIO, Naganath (Nagu) Sundaresan
■ Disciplined investment process encompassing in-depth fundamental analysis
■ The fund, through its aggressive and opportunistic characteristics and focus on growth seeks to capitalise fully on attractive investment opportunities to deliver superior returns to more index-driven equity funds
JPMF India Fund - offshore The managers' approach is primarily bottom-up, but also includes a top-down overlay. Although the managers do take active bets, they remain mindful of the composition of the index. In addition, the large size of the fund makes it difficult for the managers to participate as much as they would like in small and mid-cap companies. The fund has been a solid performer across virtually all market conditions, although it does not typically capture all of the upside in momentum-driven rallies due to its prudent focus on valuations. The fund has good defensive qualities as the management team always looks to preserve capital by moving to a more defensive stance when they feel valuations are over-extended.
Key attributes of fund and management team:
■ Solid track record - consistent and steady relative performance
■ Medium risk fund in a high risk asset class
■ Well-resourced team led by Ted Pulling, responsible for the fund since 1995
■ Managers consistently demonstrate good grasp of market's underlying dynamics
■ Disciplined application of ideas to ensure effective portfolio construction
■ While based upon a model portfolio to ensure communality across funds with similar mandates, individual managers allowed discretion to enhance creativity.