Interview :: What’s happening with Indian stocks?

February 2014 |

Timothy Orchard, the Portfolio Manager of the Fidelity India Fund, and Portfolio Advisor Sandeep Kothari share their views on the state of India and how they have positioned the Fund for 2014.

What is your vivew on the state of the India’s economy?

Tim: For the past two to three years, indecisive policy-making and weak governance led to deterioration in domestic economic fundamentals and a negative knock-on effect on corporate earnings and valuation. However, recent policy measures seem to be working and the country’s macro-economic environment is showing signs of an improvement. The recent initiatives to contain the current-account deficit and rein in currency depreciation seem to be working. The government looks keen to meet its fiscal deficit target. Although inflation remains high, it is likely to ease from here.

Overall, I think that India remains a strong domestic growth story. It has the potential to grow 7% to 8% annually but for that potential to be realised, appropriate policies and effective execution need to be in place. If a reasonable government is elected in the upcoming general elections in May 2014, we could see the economy reverting to its higher growth trajectory in the medium term.

Sandeep: I would agree with Tim that there is much to be optimistic about India. Although cyclical challenges exist, the rate of growth seems to have bottomed out and has the potential to gradually rise from here. Policy bottlenecks led to a large project backlog worth 8.3 trillion rupees (A$1.5 billion) or 7.8% of GDP. Even if some of these projects are cleared, it will lay the foundation for the next phase of growth. At the same time, the annual monsoon has been good and this is helping the rural sector. Increased food production is likely to reduce inflation and boost rural demand.

Sandeep. what are your expectations for the upcoming elections?

Sandeep: I think regardless of which party wins, the process of liberalisation and economic reforms is irreversible. We have seen this during 1996 to 1998 when a coalition, third-front government came into power. If the recently held provincial elections are any indication, voters are concerned about the state of the economy, corruption and governance. Thus, any party that comes to power will be expected to re-start the investment cycle, contain the “twin” deficits and tame inflation. Curbing corruption in public places is another major issue which would have to be a priority.

Tim, how do you work with Sandeep?

Tim: Sandeep is our in-house India expert and plays a crucial role in stock selection for the Fund. He was the Country Head of Equity Investments between 2006 and 2012 based in Mumbai. After we sold our Indian business in 2012, we retained Sandeep and the research team. Now, Sandeep devotes all his time as the Portfolio Advisor for Fidelity’s India funds.

Sandeep has a well-established investment process. Although he is based in Singapore, much of his time is spent in India working with our Mumbai-based research team. He constantly visits companies, meets managements and other stake holders, government officials and regulators to form his investment thesis and pick high-quality companies with scalable business models available at attractive valuations into the portfolio.

I contribute my portfolio-construction and risk-management expertise to the Fund. As Head of Equities for Asia ex-Japan, I have been overseeing regional managers’ portfolio construction and risk management. My focus is to help generate consistent long-term, risk-adjusted returns for our clients.

How have you positioned the Fund given your market outlook?

Sandeep: The Fund is structured to take advantage of the long-term growth prospects of the Indian economy. Since we assumed management responsibility, we have made a few changes. For instance, the exposure to higher-conviction holdings was increased and some of the smaller holdings were offloaded. We increased the stock-specific risk in the Fund while keeping country and currency risks under control. The portfolio is evenly balanced between firms that benefit from overseas demand and those that gain from India’s consumption and economic growth potential.

Domestic consumption remains a secular growth theme and consumer discretionary is our biggest sector-level overweight. We prefer industry leaders or market-share gainers with a strong franchise and a scalable business. Meanwhile, we are underweight the consumer staples largely due to valuation concerns.

Among exporters, Indian generic drug manufacturers and IT services providers continue to see strong demand from overseas markets such as the US. While strong demand and a large number of patent expiries coming up present a favourable environment for Indian drug manufacturers, the IT services sector is benefiting from the recovery in the US and European markets. Ongoing rupee weakness is an additional revenue boost for these firms.

Among cyclical sectors, the banking sector has been adversely affected due to a fall in asset quality, while industrials were hit by a slowdown in capital spending. We have increased exposure to these sectors given attractive valuation and a likely benefit from a recovery in investment cycle. Among banks, we remain focussed on the private sector players in the retail space with well-capitalised balance sheets and low levels of non-performing assets.

Could you talk about some of your major stock ideas?

Sandeep: The largest active position is ICICI Bank, India’s largest private sector bank. It has a strong franchise and is focused on urban retail customers. Its asset quality is better than that of the banks that focus on the corporate sector. As the economy improves, ICICI Bank’s assets should grow at a faster pace than the industry average. The management’s focus on improving productivity and branch efficiency should yield additional benefits.

Dr Reddy’s Laboratories is a large generic drug manufacturer in the portfolio. The firm has a solid product pipeline in both the developed and emerging markets. More importantly, the quality of drug approvals in the US demonstrates the strengths of the company’s research capability. Its quality financials, healthy operating margins, a clean balance sheet and a high return on equity completes our thesis for the stock.

The largest active position in the consumer space is the shoe retailer Bata India. There are three main factors that drive its performance. Firstly, the Indian footwear market, which is largely unorganised, underpenetrated and largely utilitarian, is seeing a shift towards organised retailing and branded products. This benefits Bata, which has a strong brand recall and an extensive retail network. Secondly, Bata operates in the affordable segment with virtually no major threat to its leadership. Lastly, the management is actively seeking higher margins by improving product mix and changing the store format to attract a younger demographic.

The Indian stock market is close to its all-time high. What makes you confident about Indian equities?

Sandeep: While Indian equities are close to their high levels, valuations are still below their long-term average. Meanwhile, recent earnings downgrades mean that there is scope for earnings surprises if the economy improves.

There are two factors that make us confident about India. First, our belief that over the long term, equity-market performance is aligned to economic performance. Most experts would agree that India is one of the most promising long-term domestic growth stories in the world and, despite all its inefficiencies, the country has a strong and stable democratic political system.

Second, the ability to invest in a broad range of Indian companies, in terms of their areas of operation, business size, business quality, corporate governance standards and so on. Investors have the choice to stay with defensive, high-quality businesses during challenging times and invest in the more cyclical parts of the economy when growth is strong. This makes India an attractive destination for stock-pickers throughout an economic cycle.

Important information

Any references to specific securities should not be taken as recommendations and may not represent actual holdings in the portfolio at the time of this viewing.

Investments in small and emerging markets can be more volatile than in more-developed markets.

Investments in overseas markets can be affected by currency exchange and this may affect the value of your investment.

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