Following Prime Minister Narenda Modi successfully securing a second term in office, India is set to embark on the next stage of the ruling BJ Party’s highly ambitious modernisation plans. With an economy experiencing a significant slowdown in growth, oil price declines, and teething issues from reforms made by the ruling party in its first term, the country arguably remains a mixed bag for investors.
As it stands, the opportunities provided by its economic potential and population size, alongside the mandate now enjoyed by Mr Modi with in both the upper and lower houses of government, are counterbalanced by significant volatility and deep-rooted problems plaguing the financial sector.
Over the next five years, Mr Modi could enact sweeping reforms to match his corporation tax and goods and services tax reforms. His plans on property, infrastructure, agriculture and the financial sector could potentially boost its flagging economy. With GDP growth dropping from eight percent to five percent in the space of five quarters, such restorative measures could have tangible effects.
Growth opportunities
David Cornell is the chief investment officer at Ocean Dial Asset Management, and manages its India Capital Growth Fund. It is a trust which predominantly focuses on small-cap and mid-cap opportunities across India, aiming to provide investors with long-term capital appreciation, for an annual management fee of 1.25 percent of assets under management.
Mr Cornell hopes it provides the “best of both worlds” for investors, as the India Capital Growth Fund utilises analysts in Mumbai to pick the stocks in the portfolio and assess the market, while in London the company has an institutional office where the risk assessments takes place.
Explaining his fund’s ethos in admirably succinct terms, he says: “We are about absolute returns, we are about generating wealth, and we are about long-term investment.”
Expanding on the fund’s approach in greater detail, Mr Cornell adds: “The philosophy is to do a lot of work on the companies before we buy them and use the volatility of the market to buy stocks at attractive valuations. We are going through a period of that today because India is under a lot of pressure and it gives a chance to pick up good companies at attractive values. We like to hold on to them because this compounding impact in India is very strong.”
Currently, the fund has 32 holdings with a turnover of approximately 12 percent, which equates to stocks lasting in the portfolio for around four to five years. Its top 20 equity holdings, which make up approximately 70 percent of the portfolio, are spread across a wide selection of sectors suggesting significant confidence in India’s investment opportunities.
Tech Mahindra, an information technology stock, takes up 5.7 percent of the portfolio, while financial stocks such as Federal Bank and Union City Bank both represent over five percent of the portfolio as well. Meanwhile, material stocks such as Berger Paints India and PI Industries round off its top five, with consumer staples such as Jyothy Laboratories and health care stocks like Divi’s Laboratories featuring in the top ten.
What sets the fund apart from its competitors, in Mr Cornell’s mind is its emphasis on pure-active management and the quality of its selections.
He explains that its diligence is very detailed and requires extensive groundwork, with his team visiting plants, factories and management groups. It requires the fund to assess not just the competition, but also the supply chain.
“Because we don’t invest in an area of the market where most of our competition do necessarily, ie. the top 100 names, we have a much more active process,” he explains.
Mr Cornell also acknowledges that despite this forensic approach, the possibility of rough patches remains. He even states that the annualised volatility of the fund is around 23-24 percent, making it “volatile” in his words.
This is, in his view mitigated by nature of the fund’s set-up.
He outlines that the benefit of the investment trust and its close ended structure, is it gives fund managers the freedom to buy and sell according their understanding of the value that is available.
“Rather than just buying and selling because he has money coming into his fund or he has money coming out of his fund. In a volatile area of the market, that close-ended structure is really valuable,” he adds.
Setbacks
Following the financial difficulties experienced by Infrastructure Leasing and Financial Services Limited (IL&FS) last year, which resulted in the unlisted infrastructure lending giant defaulting on key payments last year and suffering multiple downgrades of its investment rating, Mr Cornell’s fund found itself in a challenging situation.
With the fallout still being felt in the Indian economy 12 months later, the India Capital Growth Fund reported last month that its net assets declined over the first half of 2019. Compared to its figures in December 2018, the fund’s NAV share declined from 101.65p to 97.02p six months later at the end of June. Its total equity declined 4.5 percent during the same period, dropping from £114.4 million to £109.2 million.
When explaining his reaction to the fund’s performance difficulties this year, Mr Cornell remains fairly equivocal in his response, noting that that there is a saying about investing, which is that it might be simple but it’s not easy.
Mr Cornell believes that powerful headwinds, particularly in emerging markets, are difficult to avoid. He notes the negative effect of IL&FS’ financial woes on the fund, but considers the fund’s struggles to be representative of the wider problems the default had across India.
Not that he doesn’t accept responsibility for the fund’s stuttering performance.
He says: “In an emerging economy there are unforeseen risks, there is volatility and we do make mistakes, definitely.”
Nevertheless, there are ramifications from the fallout at IL&FS, with the India Capital Growth Fund now trading shares at a discount to the NAV.
“Obviously raising fresh capital, when shares trade at a discount to the NAV is difficult,” explains Mr Cornell.
Ultimately, however, this setback will not drastically change the fund’s approach or his viewpoint on the opportunities available for investors looking for growth potential in India.
Commenting on the response to this potentially chastening setback, Mr Cornell says: “The message I would like to get across is that as a house we have not and will not change our investment process as a function of the changing economic scenario. There will be periods when we underperform. We are going through one of those periods now, but if we started chasing every different investment theme that was happening in the market, we would find ourselves whip-sore 99 times out of a 100. So, investors have to understand that our process is consistent and disciplined and in time we believe small and mid-cap stocks will come back into vogue. When they do, this trust will start performing very strongly again.”
Ultimately, he explains that his fund is trying to differentiate the signal being transmitted by India, with its multiple short-term deficiencies from the long-term trends in the fund.
He says: “We don’t invest in short-term thinking and if the market starts going down 10 percent that improves risk/reward profile as its 10 percent cheaper.”
Mr Cornell remains confident of the trust’s potential, with it currently sitting at approximately £100.1 million in assets under management.
He says: “The fund has the ability to be upwards of £300m in terms of its capacity without changing the nature of the stocks we are investing in. We will continue to focus on small and mid-cap areas of the market and increase the size of our fund by three-fold.”
Forecasting India’s future
Mr Cornell states that the macroeconomic policies of Mr Modi are not used to drive stock selection.
He says: “The fund is a bottom-up stock-picking fund. So, the stocks that go into the portfolio go into the portfolio on the basis of the individual companies’ valuation and risk/reward profile.”
That said, he does speak positively about Mr Modi’s policies, and accepts that a brighter economic outlook would improve the performance of his holdings.
The fund manager believes that reforms to the banking sector could be especially important.
“As long as government has control of the financial system, the allocation of capital is mistreated. That leads to the financial crises we are currently enveloped in,” he says.
Ultimately, he is optimistic about Mr Modi’s reforms, believing the prime minister’s ambitions are achievable. He notes that the BJ Party’s leader was often unfancied by experts in the run-up to the election with many expecting him to lose his majority, instead he came up trumps at the ballot box.
“This means people voted for him and they voted for him because every village in India now has electricity - over 100 million toilets have been installed. These are areas of wellbeing that stock market investors rarely focus on or care about but do matter hugely for the man on the street,” he argues.
When it comes to the future prosperity of India, Mr Cornell remains an optimist with Mr Modi at the helm, believing him to be the only man to bring together a country as vast and as diverse as India, and make the structural changes required.
“If not now, when? A second term in office with a stronger mandate is as good an opportunity as you can ask for,” he says.
