There is many a Western business that has spotted an opportunity in emerging markets but found themselves thwarted by not fully understanding the idiosyncrasies of the local market.
Home Depot, for example, did not realise the Chinese had little appetite for home improvements; Mattel didn’t realise that emerging market consumers wouldn’t want $100 (£77, €86) Barbie jeans.
The advantages of local understanding should not be underestimated, particularly at a time when emerging markets are becoming more reliant on each other.
This is where Reliance believes it has an edge in its India Equities Portfolio. The team are based on the ground in India, understand its nuances and consider they are in a better position to assess the strengths and weaknesses of individual companies. They also have a significant presence of analysts to take advantage.
Most companies in India not covered by brokers
Manish Gunwani (pictured), Reliance Nippon Life Asset Management’s chief investment officer, says: “We believe you need to be large. There are around 5000 companies in the Indian market, and only 100 are covered by the sell side. In other words, most companies are not covered by brokers and are difficult to access.
“Reliance has a large team and has been there for a long time, tracking Indian companies for many years. India is culturally different and you need to be on the ground to understand it.”
The group start with a market cap screen that limits its universe to around 800 companies. A further quality screen weeds out those companies with weak balance sheets or excessive debt.
This will also look at management track record, corporate governance, corporate access and structural industry issues. It leaves them with around 470 companies. This is the group’s ‘active universe’ and each company will have a Reliance analyst assigned.
Corporate fundamentals are key
Its approach is based on the view that corporate fundamentals will, in the long-term drive share prices. That means the fund managers take a benchmark agnostic, conviction-based stock picking approach.
Nevertheless, the group also recognise that macro-economic factors can have an influence in developing markets and they incorporate this into their analysis. It means that performance may look very different to the index.
This can be good – in 2017, the fund returned 50.1% against a performance from the MSCI India of 36.9%, but it has worked the other way: in 2018, with the portfolio down 12.9% against a fall of 1.7% in the index. Over the long-term, however, performance has stacked up well.
Clouds gathering
Should the recent strong performance of Indian markets worry investors? Certainly, there are some clouds gathering in the market.
Prime minister Narendra Modi, the architect of much of the recent reform, faces a less certain future. There is a general election in 2019 and three BJP (Modi’s party)-ruled state elections in 2018.
There are concerns around slippage on important fiscal reforms, and on the impact of a long-term capital gains tax on equities. Interest rates may also be about to rise, which would create some headwinds for companies.
Trump’s trade war
There are also global factors. While India is not a significant target of President Trump’s trade war, it is a major importer of oil and is hurt by the stronger Dollar. It remains a relatively self-contained economy and therefore less vulnerable to global weakness, but it cannot remain immune from factors influencing its near-neighbours.
For the time being, the economy still looks in robust shape, however. The most recent figures show an annual growth rate of 8.2% and it is now reaping the rewards following major disruptions such as demonetisation and the goods and services tax. Gunwani is also seeing this reflected in corporate performance with stronger earnings growth.
He believes investors need to look longer term: “Over the next 10 years, we will see an incredible amount of growth. Today, over the next decade the economy could triple in size. That’s what keeps us excited. Good demographics have been key in strong-growing economies and here, India has a notable edge.”
Modi’s reforms
There is also scope for considerable productivity improvements, which should improve as technology and infrastructure improve. India has proved itself good at both.
He adds: “Modi’s reform drive has tackled corruption, aiming to flush out the black market in to the formal economy. Modi has also been good at persuading the world that India is a superpower and to back it. $650bn is going into infrastructure – roads, railways, flight. This is connecting towns and cities.”
Volatile markets
Nevertheless, the fund now reflects a more volatile and uncertain market climate. Gunwani has been diversifying more recently – increasing the fund’s holdings from 33 to 48. He has also increased the weighting of large caps in the portfolio.
At the start of the year, there was a huge valuation gap with small and mid-caps trading at 25-30% higher multiples to large caps. The weighted average market cap of the portfolio has increased from US$8.4bn to US$20.5bn. He has also improved overall quality of the portfolio in response to a more difficult environment.
The portfolio bias towards exporting companies has increased, from 26.5% to 33%, largely in response to a depreciation in the currency, which has improved prospects for these companies.
The group has also been increasing its exposure to consumer stocks, Gunwani says: “We believe in consumer stocks. Per capita income is increasing people’s ability to spend on clothes, drink, biscuits and so on. This is a major long-term trend.
“We also believe financial services is going to be a big industry. Money that used to go into property and gold is now going into Indian equities.”
Top holdings include Varun Beverages, which does the bottling for Pepsico, and 126-year old biscuit maker Britannia.
India is rich with opportunities, but it takes effort to uncover them. Being part of India’s largest publicly-listed company gives Reliance a notable advantage.
