Trading the new normal in India

May 1, 2012

After a ghastly 2011, Indian stock markets have’t done too badly this year despite the almost constant stream of bad news from India. They are up 12 percent, slightly outperforming other emerging markets, thanks to  fairly cheap valuations (by India’s normally expensive standards)  and hopes the central bank might cut rates. But foreign  inflows, running at $3 billion a month in the first quarter, have tapered off and the underlying mood is pessimistic. Above all, the worry is how much will India’s once turbo-charged economy slow? With the government seemingly in policy stupor, growth is likely to fall under 7 percent this year. News today added to the gloom — exports fell in March for the first time since the 2009 global crisis.

So how are fund managers to play India now? According to David Cornell, who runs an India portfolio at specialist investor Ocean Dial, they must simply get used to the “new normal” — subpar growth and high cost of capital. In this shift, Cornell points out, return on assets in India has fallen from a peak of almost 14 percent in 2007 to less than 10 percent now. While that is still higher than the broader emerging asset class, the advantage has dwindled to less than 1 percent as companies suffer from margin compression and falling turnover. Check out these two graphs from Ocean Dial:

Cornell is playing the new normal by focusing on three sectors — consumer goods, banks and pharmaceuticals. These companies, he says, have pricing power and structural barriers to entry (banks); provide access to still-buoyant demand for services such as mobile phones (consumer goods) and are well-run and profitable (pharmaceuticals). And the export-oriented pharma sector is also an effective hedge against the weakening rupee.

If cost of capital is high, you want to avoid leverage, you want to be in banks which have pricing power. In pharmaceuticals you have 20 percent earnings growth and transparent accounting. In an uncertain environment these sectors should perform well. (Cornell says)


In general, fund managers seem to be fairly positive on India despite the economic gloom and the government’s best efforts to drive them away via ill-reasoned initiatives such as attempts to retrospectively tax some investment gains.

Hugh Young, who co-manages Aberdeen Asset Management’s Asia ex-Japan fund, has 12 percent of his portfolio in India, a substantial overweight, induced by the high quality of Indian companies. His sector picks are similar to Cornell’s –he favours HDFC Bank as well as the Indian subsidiaries of Glaxo and Unilever. Young says:

Compared to many investors I do like India. It has great companies. But its government is truly hopeless, announcing decisions one day and backtracking the next and then re-introducing them in diluted form. But we have a long-term horizon and the market trades 13 times forward earnings which is at the lower end of the historical range…. we haven’t found any of the quality in Chinese companies that we have in India.

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