by Jeff Reeves | August 6, 2012 9:14 am
India has been one of the most attractive emerging markets for some time, partially because of its status as a member of the BRIC quartet along with Brazil, Russia and China.
However, all of these core emerging-market plays have their own challenges. Data continues to point to a slowdown in China. Brazil is suffering under inflation and stagnant growth. And Russia … well, things are OK, but the IMF is worried that the Kremlin underestimates the crash potential it faces right now.
So should you give up on emerging markets? Probably not. With America and Europe in dire straits too, you can’t afford to limit your scope. Investors these days need emerging-market stocks more than ever — so long as they have the discipline to find the best opportunities and be selective.
I recently had a back-and-forth with Adrian Lim, the brains behind one of the top India vehicles out there. This closed-end fund — aptly and simply named The India Fund (NYSE:IFN) — is managed by Aberdeen Asset Management Asia.
Lim joined Aberdeen in December 2000, working previously at Murray Johnstone and at Arthur Andersen advising clients on mergers and acquisitions in Southeast Asia. He moved on to the Asian equities team in July 2003. He attended university in Singapore and is a CFA charterholder.
Here’s what Lim had to tell me about the state of the Indian economy, some of the best individual equities investors should watch and how his fund is cashing in on growth in this emerging market:
Q: India’s growth rate likely will hit a 10-year low in 2012. It’s obviously a complicated mix of causes, but what are the biggest issues in your opinion?
A: The global slowdown has hurt external demand, but India’s economic downturn has been largely of its own making. High interest rates are needed to contain stubborn inflation, but they in turn deter consumer demand and investment. At the same time, the weak rupee makes imports more expensive, aggravating price pressures and limiting room for monetary easing.
Policy inaction and a hostile investment environment have been equally unhelpful. The ruling Congress party has caved in repeatedly to vested interests among its coalition partners, thus weakening public confidence in its leadership. To counter the slide, it needs to support investment and push through economic reforms, which are sorely lacking as highlighted by recent protracted blackouts and overstretched public finances. The appointment of experienced, pro-reform Palaniappan Chidambaram as finance minister has been widely welcomed by business groups, but we are taking a measured view; Delhi’s indecisiveness has been frustrating.
Q: There’s always talk in America about a “do-nothing Congress.” How is government in India, the largest democracy in the world, similar to our own political mess?
A: India’s political structure is broadly similar to that in the U.S. But unlike the U.S., where there are two dominant parties, India has a plethora of political parties, which are sometimes divided along the lines of religion, caste and language. Because national elections rarely produce a clear mandate in favor of a single party, coalition governments are increasingly the norm in India. Unfortunately, multi-party alliances — where smaller parties can prove disruptive — have in large part resulted in an absence of clear policy direction and forced a series of policy U-turns ranging from foreign investment in the retail sector to rail fares and petrol prices.
Q: Despite challenges in India, there obviously are opportunities if you know where to look. What are some sectors and specific companies you believe best illustrate the potential?
A: As bottom-up stock pickers, sectors are a secondary consideration to our investment decision-making — stocks come first. Specifically, we look for conservatively managed companies with solid balance sheets, sustainable business models and stable growth prospects. And India really does have some of the best companies in Asia and globally.
We have large holdings in the likes of mortgage lender HDFC Bank (NYSE:HDB) and ICICI Bank (NYSE:IBN) among financials, as well as big positions in consumer names such as Hindustan Unilever, a wholly separate stock that is listed in Bombay but 52% owned by British-Dutch consumer giant Unilever (NYSE:UL), for which it is named; ITC Limited, an associate of British American Tobacco; and Godrej Consumer Products, the country’s biggest home-grown consumer goods company. A burgeoning middle class with rising disposable incomes bodes well for these companies.
Another chunky position is in the IT services sector, where we have substantial exposure to Infosys (NASDAQ:INFY) and Tata Consultancy Services. These companies are globally competitive with world-class software engineering teams and generate healthy cash flows.
Q: The U.S. financial sector is a mess due to scandal, regulatory fights and other shenanigans. Some of your top holdings right now are India banks, including HDFC and ICICI. How is the India financial sector different (or similar) to banks in America?
A: India’s banking sector is as vibrant as the U.S.’s. But it is far more fragmented; the country has few large banks, but many small ones. Additionally, the penetration level of the financial services sector still is very low. In other words, there is significant potential for growth, particularly as rising incomes boost consumers’ purchasing power. Our large exposure to this sector reflects our view that banks will play an increasingly central role in providing finance for consumer spending. But care must be taken to pick the right banks — i.e., those that are being run on a commercial basis.
As mentioned, a core holding here is HDFC, which has maintained its sound capital position and weathered the stresses of high interest rates and slower loan growth very well. We also hold its associate, HDFC Bank. Both have been recording healthy net interest margins while growing their loan portfolios. Another of our key investments is ICICI Bank, a leading lender whose strength is in the urban retail segment. ICICI Bank has been strengthening its balance sheet and consolidating its capital. Its management is committed to bolstering its deposit base before pursuing further loan growth. Also noteworthy is that our private bank holdings, unlike their state-owned counterparts, have fared better in maintaining their asset quality.
Q: Investors have access to some of the stocks in your portfolio such as HDFC, ICICI or Infosys as ADRs that trade on U.S. exchanges. But why should they consider investing more broadly in your fund instead of a few India stocks like these?
A: India has over 7,000 listed companies (on the Bombay stock exchange) in industries ranging from IT, banks, materials, consumers and pharmaceuticals. Aside from subsidiaries of top multinational companies, India also has many first-rate home-grown businesses. To tap that huge potential, investors need broader access.
There are caveats, however. India embraces both the best and the worst. The best are conservative because their owners’ money often is in the business and they hate to misuse it, yet at the same time they are respectful of outside shareholders. But as in many of the large emerging-market countries, it takes time to develop a deep understanding of where the best investment opportunities are, which is why we see our track record of investing in India for 15 years as an important competitive advantage. Over that time, our proven process based on firsthand research has uncovered companies whose quality is second to none — not just in India but across Asia. And our stable investment team, having worked closely together over many years, allows us to exploit fully the opportunities as and when they arise. Taken together, we believe our fund has the potential to deliver attractive returns to our investors.
Q: So give me a global economic forecast for the next 12 to 18 months: Better times ahead in 2013, or worse times ahead?
A: In the near term, it is difficult to see better times in global capital markets. Europe’s debt crisis remains at the fore. The underlying imbalances of banking sectors and sovereign borrowers have yet to be resolved, while austerity policies have weakened economies. The U.S. economy, meanwhile, remains tenuous. The housing market appears to be steadying, but persistently high unemployment has impeded consumer spending. The looming fiscal cliff has darkened its outlook further. Asia has not been insulated from these developments, and growth is slowing. Stock markets, therefore, are likely to remain jittery in the months ahead.
India’s real economy is relatively insulated from global developments. For example, less than 30% of the MSCI India companies are in IT or pharmaceuticals, which have significant exports. Most of the companies are domestically driven.
Q: Anything else you’d like to add that we haven’t covered?
A: There are a few things that make our fund unique. First, we have a long-term perspective — the majority of our top 10 positions have been held between five and 10 years. Second, ours is a high-conviction portfolio of some 30-40 stocks, which means it is very different from the benchmark. In fact, we tend not to look at what is in the benchmark when constructing our portfolios; paying too close attention can constrain stock selection. Third, our turnover is generally low, given our buy-and-hold approach. Instead of outright trades, we prefer to top up on price weakness or top slice on price strength. Another key point is that all our portfolios are run on a team basis. Company research duties and cross-cover visits are shared. In this way, we not only benefit from collective wisdom but also overcome blind spots.
Learn more about The India Fund at www.aberdeenifn.com.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not hold a position in any of the aforementioned securities.
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