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.

In defence of co-investing with the state

It’s hard to avoid state-run companies if you are investing in emerging markets — after all they make up a third of the main EM equity index, run by MSCI. But should one be avoiding shares in these firms?

Absolutely yes, says John-Paul Smith at Deutsche Bank. Smith sees state influence as the biggest factor dragging down emerging equity performance in the longer term. They will underperform, he says, not just because governments run companies such as Gazprom or the State Bank of India in their own interests (rather than to benefit shareholders)  but also because of their habit of interfering in the broader economy.  Shares in state-owned companies performed well during the crisis, Smith acknowledges, but attributes emerging markets’ underperformance since mid-2010 to fears over the state’s increasing influence in developing economies. (t

Jonathan Garner at Morgan Stanley has a diametrically opposing view, favouring what he calls “co-investing with the state”.  Garner estimates a basket of 122 MSCI-listed companies that were over 30 percent state-owned outperformed the emerging markets index by 260 percent since 2001 and by 33 percent after the 2008 financial crisis on a weighted average basis. The outperformance persisted even when adjusted for sectors, he says (state-run companies tend to be predominantly in the commodity sector).