Why the long-term outlook for India remains promising
This article first appears in the September edition of Professional Paraplanner magazine As one of...
Mithran Sudhir, client portfolio manager of the Goldman Sachs India Equity Portfolio fund, talks to us about the key factors that are driving India’s success on the world stage. Political and business reforms have built confidence within the country, the central bank is well placed to counter inflation, and the stock market has been the one bright spot on a dark investment horizon.
He discusses India’s tech sector and how the team is finding more opportunities there, and comments on the various ways in which India is well placed to gain market share from China.
Please Note: Below is a transcript of the video, modified for your reading pleasure. Please check the corresponding video before quoting in print, as it may contain small errors.
I’m Sam Slator from FundCalibre, and today I’ve been joined by Mithran Sudhir, client portfolio manager of the Goldman Sachs India Equity Portfolio. Thank you very much for joining us this morning.
Oh, my pleasure to be with you Sam.
So, we’ve had a lot of doom and gloom in the headlines recently. Markets, whether it’s bonds or equities, seem to have gone down around the world. So, perhaps we can start on a bit of a more positive note, because the International Monetary Fund recently described India as ‘a bright spot on a dark horizon’. The economy’s still growing very well. It’s set to overtake the UK, Germany, and Japan, to become the third largest economy in the world. What’s behind that success? Why is everything so positive in India, when it’s so gloomy in the rest of the world?
[00:48] Sure, thanks Sam. I think I’d say maybe [there are] three key factors that are driving India’s relative outperformance, if you will, on a year to-date basis.
I think, firstly, it was just India’s still coming out of a fairly strong cyclical recovery post-[inaudible]. I think if you went back to 2020 2021, we had successive kind of fairly severe waves and fairly severe lockdowns in response to that. And I think the unwinding of that is essentially what’s helping at this point.
I think the second one’s also the fruits of past reform momentum. I think the current government’s been in place for, let’s call it about eight and a half, nine years. And we’re getting to a point where some of those key reforms – goods and services tax, the, let’s say, push towards ease of manufacturing, ease of doing business, incentives for kind of increased localisation of manufacturing in India, coupled with some of the significant tax cuts that you’ve seen, are all now at a point where, post-[inaudible], those kind of benefits are finally accruing to corporate profitability.
And then the third point, is really on the fact that other countries have clearly been making certain self-goals in terms of policy. And I think just the absence of negative news flow on that front, is clearly kind of making India a relative outperformer.
And food inflation’s actually still quite high there though, and it’s an oil importer and obviously oil prices are quite high. Is that not [a] possible negative for the outlook?
[02:26] No, of course. I think, like India especially, I think on the oil side, it’s always been a key determinant of India’s near-term outlook. I do think, in that light, it feels a little weird that one of the best performing countries is a large oil importer. I think there are a couple of aspects that are important to bear in mind.
I think, first and foremost, we’re at a point where I’d say, somewhere in the 80-100 dollars oil, [is] essentially something that I think India is fairly well placed to manage. There are a few things going in into this thinking. I think, first and foremost, it is the fact that, over the medium term, for instance, you’ve got your increased capacity. The incremental gigawatt of capacity today is coming into renewables, and I think longer-term, that will make India a stable economy and less reliant on some of these fossil fuels.
But more importantly, I think over the near term where this volatility still hurts, I think some of the prior reforms, again, on this front are helping. In particular, if you think about the market linking of fuel prices, for instance, at the end consumer level. Essentially on an intraday basis, you’re seeing prices at the pump move up or down for the end consumer, based on what international crude does. So, what used to be historically a fiscal problem, and then also a current account problem, no longer becomes a fiscal problem given this is essentially passed on to the end consumer.
And obviously, the central bank has its own mandate of inflation targeting, which makes sure that if it does start feeding through into inflation, the central bank is likely to act in order to reduce that impact going forward. And, to that extent, I think India as well as kind of [the] broader emerging markets, central banks have probably been more ahead of the curve than some of their Western counterparts.
So, I think [the] headline point is that it no longer is a fiscal problem. It might feed through into inflation as we’re seeing, but clearly central banks have acted in anticipation of that.
And you’ve spoken to us in the past about some of the longer-term trends that there are, including the growing middle classes, the internet penetration, et cetera. I noticed you’ve got quite a few banks in the portfolio at the moment. Is that part of a particular trend?
[04:57] For sure. I think like a lot of the commonality between a lot of the banks specifically that we own in this portfolio, tends to be that a lot of them are a) privately owned. Like there has been a 25 year- 30-year trend of state-owned banks losing market share and private sector banks, which, you know, are fairly widely held by foreign asset managers as well, but generally tend to execute well, gain market share, have stability at the management level, all of which kind of bode [well] for strong earnings and cash flows.
I think beyond the banking space as well, there are a number of interesting ideas that we find specifically, you know, in the diversified kind of non-banking financial space, within [a] broader [field], kind of insurance, and then in the past, stock exchanges as well.
So, I think there is a whole spectrum of ideas within that financial space, which contribute to that broader [view of] overweight that you’ve seen in our portfolios historically. I do think it is still a market where basic financial services are fairly underpenetrated, and then this combination of, let’s say, universal banking push from the government, coupled with linking bank accounts to your mobile phone, to your biometrics and helping [to] push this universal banking agenda.
And then a lot of corporates [are] benefiting from this tech stack that the government has helped build, is really, I think, a trend that we are playing in our portfolios. And that’s all pervasive; that goes well beyond the banking space, as well [as] into kind of consumer and online businesses which are able to benefit from that.
And you also have about a third of the portfolio invested in smaller companies; what kind of opportunities are you finding in that part of the market?
[06:57] Yeah, of course. I think this is a crucial part of our strategy. I don’t think it’s as much a view that small- and mid-caps will outperform larger-caps over the longer term. I think for us, it’s very much the fact that, if you’ve got a strong locally-based team with deep domain expertise based in India, I think it’s important that, instead of building a portfolio where you identify larger-cap companies, where you are the 60th person on the street trying to identify some value in what is mispriced in that business, we would rather be the first or second major institution to look at this in a systematic, rigorous, longer term view.
So, I think it’s really an alpha story there, as opposed to thinking that the SMID cap [small and kid cap] segment as a whole might outperform. I mean there is [a] higher likelihood that you lose your shirt or you find multi-backers and I think we trust our team to find more of the latter than the former.
But I think specific to your question, where we’re finding opportunities, I’d say the two or three key segments would be 1) a lot of newer companies that have been coming to market, a lot of IPOs that we have invested in, in [the] last year especially, which was fairly prolific, have tended to be in that online consumer, digital, tech-enabled consumer space, which historically India has lacked as an opportunity, especially when you compare it with places like China.
I think we’re getting to a point where India’s technology sector essentially is becoming less IT services exporters dominated, and actually becoming more inward looking, if that’s even possible given India’s starting point. So, I think that’s quite an interesting pocket for us to look for opportunities and we’ve found great ideas there.
The second complex I think, which might be, maybe a little boring but often overlooked because of that, but [inaudible] specialty chemicals where a lot of smaller cap companies are benefiting from, I think, two major trends that are playing out.
First is this, you know, ‘China plus one’ sourcing policy, which a lot of international competitors / companies are having to think about considering trade-related issues, considering differential taxation, or import taxes that were being imposed, considering [inaudible] lockdowns and blockages at certain ports. Clearly these issues have made the dependence on China, become a front and center of mind issue for a lot of corporates. And I think India is fairly well placed to gain market share in that trade of reorienting supply chains, to reduce this reliance on China.
I think the second part is really also I think, from a domestic perspective, [that] the Indian government’s been pushing a lot of companies to manufacture domestically, I think at that point to the production-linked incentive scheme that came out a couple of years ago and was fairly successful on re-onshoring domestic manufacturing of mobile phones to begin with, and then broadening out. I think the combination of these schemes, along with taxation and lower tax rates for domestic manufacturing and for new manufacturing units, there was essentially a halving of tax rates.
For us, I think these were two key aspects which helped companies, kind of gave them more of an incentive to move into India, beyond just moving out of China and diversification. I think those two segments are really helping this portfolio from an alpha perspective. And I think oftentimes, those ideas tend to be in that SMID-cap space.
And finally, we’ve mentioned that the Indian stock market’s done very well over the past year or so, while everyone else has been floundering, but so much so, that a lot of investors have actually started taking profits from that area. What would you say today about people? Is it a good time to invest? Should they hold off or what are your thoughts?
Sure. I think, again, I might be slightly biased covering our India portfolios, but I really do think what you have here, is a fairly long-term structural tailwind for this asset class.
I think India’s labour force will peak in 2042. There’s another 20 years’ worth of growth in front of us, before India kind of stabilises at maybe a slightly lower growth rate.
Also, political stability that you’ve seen in the markets; corporates deliver strong earnings, notwithstanding some of these political events that we’ve seen over recent decades, should really be the paramount reason to be investing in Indian equities.
It’s a market that is always traded at a premium to a lot of other emerging markets, oftentimes most developed markets. And, we would argue, that’s for good reason. Clearly it is an entrepreneurially-driven kind of private market.
The sectoral dynamics are fairly interesting with a kind of fairly substantially higher ROEs [Return on Equity], for instance, for India than most of the world. The kind of visibility that you have on corporate earnings, for instance, over the short term as well, is fairly unlike anything else that you’re finding in a lot of other emerging markets, but also beyond that.
So, to me, I think the longer-term tailwinds are very much intact, and I think over the near term, while multiples might have corrected ever so slightly, compared to where we were, let’s say, six months ago, I still think, I mean, we’re slightly above historical average, which again, compared to EM [Emerging Markets] below historical average, might seem expensive. But, and I think for that visibility of earnings and the greater absolute levels of growth that you’re seeing, I do think India comes through as a fairly interesting attractive market, relative to kind of other parts.
And I think I go back to where you started on, [India] as ‘a bright spot on a dark horizon’ is probably an apt way of describing this. And we definitely advocate for this to be a fairly interesting entry point into what is a 20-year trade for us. And obviously, over and above that, the alpha story is still very much intact.
If you see your managers, kind of top quartile managers, come in and do their job, and deliver your annualised 4 -5% alpha that they have [been] for the last 15-20 years, I think that there’s no reason that should be any different going forward.
That’s fantastic. Thank you very much indeed.
Perfect. No, thanks for your time, Sam, my pleasure to be with you.
And if you’d like to find out more about the Goldman Sachs India Equity Portfolio, please go to Fundcalibre.com
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