Opinion

James Saft

Modi mania and activism show growth premium: James Saft

May 20, 2014

By James Saft

(Reuters) – Investor enthusiasm for new Indian Prime Minister-to-be Narendra Modi and for activist investment may spring from a common underlying cause: the reality of lower, less explosive growth.

India handed Modi and his Bharatiya Janata Party (BJP) a thumping victory in elections last week, setting off an equally explosive rally in shares, which jumped as much as 6 percent on the day of voting.

On the surface India’s rally, essentially a bet that Modi’s pro-business and development policies will succeed, seems very different from the joy with which investors have taken to greeting news that an activist investor has taken a stake in a company and is banging the table for change.

Underneath both can be seen as a reaction to more difficult times, conditions in which growth is at a premium.

Just as investors push for yield when interest rates decline, taking on more risk in search of a little extra return, so do they put a premium on potential cash flows as growth declines. That can be via genuine organic growth, as Modi hopes to create with infrastructure investment, or it can be the result of financial engineering, as with the share buybacks and dividends so often demanded by activists.

In both cases we get what may be an outsized reaction to changes in policy simply because more difficult conditions make small, incremental increases in outcome that much more valuable.

While the hope within an Indian context is for faster growth, the reality in the rest of the world is less upbeat. Not only did both the euro zone and U.S. economies barely make headway in the first quarter, but Chinese growth, long to be relied upon, has sputtered. Citigroup’s Economic Surprise Index, which measures economic data relative to expectations, is in negative territory for the U.S. and Japan, is negative and falling in Europe and has more or less fallen off a cliff in China.

That weakness in China, which is growing but far less rapidly than we are used to, is ironically making the hope of future growth in India that much more attractive. Indeed foreigners front-running a Modi victory committed upwards of $16 billion into Indian shares in the past six months, taking their holdings to more than a fifth of all Mumbai-listed issues.

None of this is to say these are the correct strategies, but they certainly become more attractive to investors when the low-hanging fruit elsewhere has been plucked.

RARITY PREMIUM

But India, history shows, is a difficult place in which to effect ‘business-friendly’ reform, and though Modi and the BJP have the best mandate in decades successes will carry political costs which may make them self-limiting. Growth too, as ever with structural change, will only come at a considerable delay to when the reforms are begun, much less when elections are held. It seems likely, then, that the market is crediting Modi and the BJP party with perhaps a bit more ability to get things done immediately than they will display.

Are Indian shares worth 8 percent more than a month ago? Impossible to say, but very likely that they have enjoyed a tail wind because of the lack of positive stories elsewhere. After all, there aren’t that many societies these days with more than a billion people and better growth prospects than a year ago. That lack increases India’s value, regardless of its degree of success in enacting reforms.

The lack of great growth stories is also very likely part of the reason for the growing popularity of activist investing, which at its best is really no more than shareholders playing their proper role as owners. More than $3.5 billion net cash flowed into activist hedge funds in the first quarter alone, according to Hedge Fund Research, well over double the pace in 2013.

Though activists haven’t got anything like a monopoly on knowledge of how to extract value from a company, it is very likely that they get a better hearing, both from corporate boards and from other investors, during times in which organic growth is more difficult to come by.

Take Apple for example, which came under pressure from activists Carl Icahn and David Einhorn over the past year, positions taken after the company amassed a huge cash pile and seemed less sure-footed in expanding its product lines.

Though Icahn eventually dropped a proposal seeking $50 billion of additional share buybacks, Apple did come through with much of what they’d been asked for. The company’s earnings in April featured $30 billion in new buybacks, a 7 for 1 stock split and a big hike in its dividend.

If the current period of slower growth proves protracted, we can expect many more such stories, both corporate and national, and an increasing willingness by investors to pay a premium for hoped-for improvements.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(James Saft is a Reuters columnist. The opinions expressed are his own)

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