Global Investing

In India, no longer just who you know

It’s not what you know but who you know. There are few places where this tenet applies more than in India but of late being close to the powers in New Delhi does not seem to be paying off for many company bosses.

Look at this chart from specialist India-focused investor Ocean Dial. It shows that since mid-2011 companies perceived as politically well-connected have significantly underperformed the broader Mumbai index. The underperformance has intensified this year.

According to David Cornell, portfolio manager at the fund, this is down to several factors such as The Right to Information Act which has helped curb unfettered corruption as well as shifting political power away from the centre towards provincial governments.  He says:

Political connections at a corporate level are no longer a pre-requisite for stocks to perform. Stay away from areas of the economy that rely on government patronage such as real estate, mining and power.

On Friday, media reported that Reliance, a giant company once seen by many as exemplifying India’s politics-business nexus, would not be allowed to recover $1.2 billion costs before starting to share gas production profits with the government.  Reliance shares slumped 1.7 percent after the report. This year they have risen just 4 percent, less than half the gains of the Mumbai index.

Trading the new normal in India

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.