Case to invest in India’s diverse, fast-growing economy

Photo of Alva Devoy, Fidelity By Alva Devoy, Fidelity

min read

Emerging market giant is where China was 15 years ago.

Fidelity is often asked about India and why investors should consider it, either through a standalone allocation or through an emerging-markets portfolio. On one hand investing in one of the world’s fastest-growing economies sounds sensible. But equally, investors have concerns about volatility and risk, particularly macro risks.

One of the most obvious reasons to invest is the size of India’s economy and its rate of growth. It is now the seventh largest and the fastest growing major economy, and should reach a top five position in the next couple of years, according to the IMF World Economic Outlook.

Essentially, India is in the position China was 15 years ago – poor, but growing fast.

Graph 1: India is where China was in 2006 in GDP per capita

Source: World Economic Outlook Database, October 2018

India’s economy is not only big but also diverse, with a huge number of companies across industries and sectors.

Graph 2: India’s broad investment universe

Source: Thomson Reuters Datastream, Fidelity International, January 2019

If we look at the top contributors and detractors to performance for Fidelity’s India Fund for the past 10 years we can see they are quite different.

HDFC Bank, the largest contributor, is one of India’s largest private sector banks. Low-cost products and good asset quality have given it a strong competitive advantage in an industry that is expanding rapidly as people swap from state-owned banks to more efficient private ones.

Maruti Suzuki, another top contributor, is India’s largest passenger car manufacturer, holding a dominant position and strong brand equity in India’s under-penetrated automobile market. Conversely, an underweight position in software services company Infosys detracted from performance.

Fidelity portfolio adviser Sandeep Kothari says: “Performance at a sector level has been well spread out. All sectors, except consumer staples, where we have been underweight due to expensive valuations, have made a positive contribution to relative returns over the five-year period.”

India’s large and diverse economy means investors have access to a broad investment universe and benefit from greater diversification, which is quite a different proposition from investing in many global equities portfolios that are often dominated by mega-cap tech stocks.

The other obvious reason to invest is the potential to generate strong returns. Over the past 20 years Indian equities have provided 9.8 per cent annualised returns in US-dollar terms despite some short periods of volatility. (Source: Thomson Reuters Datastream, 31 January 2019.)

Graph 3: Long-term uptrend despite short periods of volatility

Macro risks
Risks include currency fluctuations, an upcoming election and a potential trade war between the US and China. Just how resilient is India to these issues?

On the positive side, India has a large domestic economy with several structural drivers, such as a young and growing population, increasing penetration of goods and services, rising urbanisation and efficiency gains due to infrastructure development.

As a result, about 70 per cent of GDP comes from private consumption and the economy has a structurally higher growth rate of around 6-7 per cent.

Furthermore, India’s share in global exports is less than 2 per cent and its exposure to China and the US is lower than many nations, making it quite resilient to a trade war.

On the other hand, India runs a trade deficit and is one of the largest importers of oil. A rise in oil prices and/or currency depreciation against the US dollar would adversely impact its trade balance and create inflationary pressures on the economy.

Also, the Indian economy is dependent on foreign capital. Fund flows into the country could reverse if a trade war led to higher inflation in the US, rises in US interest rates and the resultant strengthening of the dollar.

India’s general election in May has the potential to generate some short-term volatility. Fidelity Investment Director Medha Samant does not believe this to be a large concern. “A win for the Third Front coalition would be the worst-case scenario,” he says. “We think that’s unlikely but if it were to happen, the impact should be relatively short term as economic reform has been pretty consistent under various governments.”

Opportunities
(Editor’s note: Do not read the following ideas as stock recommendations. Do further research of your own or talk to a licensed financial adviser before acting on themes in this story).

Apart from its standalone opportunities, India also plays an important role in emerging markets portfolios. Alex Duffy, Portfolio Manager of the Fidelity Global Emerging Markets Fund, spends a lot of time researching high quality opportunities in India because of the number of domestically focused businesses with strong returns and attractive reinvestment opportunities.

In Duffy’s opinion, key areas of opportunity are selectively in the financial space, where he has been a long-term shareholder of HDFC Limited (a home finance origination business) and HDFC Bank, India’s largest retail bank.

“Both these companies are premium quality businesses in their own right, led by a highly competent management team who have consistently generated healthy and sustainable returns on capital,” Duffy says. “Each business dominates its end market and has sustainable funding cost and risk management practices relative to their peers, which helps to perpetuate the return profile.”

Another area of interest for Duffy is IT services, where the fund has sizeable exposure to Tata Consultancy Services. This is another market-leading business in its industry and generates very attractive cash flows.

Duffy says growth opportunities for Indian equities have become increasingly well recognised. “This makes stock selection more challenging as valuation risk or companies being overpriced due to heightened demand is often why Indian stocks are excluded from my portfolio. I’ll certainly be looking to take advantage of any market corrections to increase exposure as valuations become more reasonable.”

About the author

Alva Devoy is Managing Director of Fidelity International Australia.

Investors can access India’s opportunities through the Fidelity India Fund or the Fidelity Global Emerging Markets Fund, which is available as a managed fund and an active ETF, via ASX.

From ASX

The ASX mFund service is a convenient way to access some of the market’s top global equities funds. To find out more about mFund and how to diversify your portfolio with less effort, visit ASX.com.au.

The views, opinions or recommendations of the author in this article are solely those of the author and do not in any way reflect the views, opinions, recommendations, of ASX Limited ABN 98 008 624 691 and its related bodies corporate ("ASX"). ASX makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, ASX excludes all liability for any loss or damage arising in any way including by way of negligence.

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