Fund Focus: India’s reforms present opportunities

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on October 23, 2017 - October 29, 2017.
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A lower current-account deficit, all-time high foreign reserves and the introduction of the Goods and Services Tax (GST) have led to a positive outlook for India. According to Rana Gupta, managing director (Indian equities) at Manulife Asset Management Services Bhd, there are big opportunities in the consumer discretionary, financial and consumer staple sectors due to the reforms of the Indian government.

“India has had a large informal economy. About 50% of its economy is informal — it is small, cash-based and inefficient. Thus, the government has taken steps to improve this and shift to a more formal economy,” says Gupta. 

One of the steps is the People’s Wealth Scheme (PMJDY), spearheaded by Prime Minister Narendra Modi in 2014, to promote better financial inclusion. The scheme allows citizens with valid official documents, such as voter’s identity card or job cards, to open an account at any bank branch without a deposit. 

The account holder is then eligible for benefits such as access to pension and insurance products. Those without valid official documents can open a “small account”, which have limitations on aggregate credits, aggregate withdrawals and bank balances. 

Before PMJDY, only half of the adults in India had bank accounts. According to a report by non-profit organisation Consultative Group to Assist the Poor (CGAP) in February, the programme has seen 260 million accounts opened in just over two years. 

“Because of the reform, many people who were not eligible for bank loans previously can now get them. It is also at lower rates, which has resulted in a notable growth of household savings in India,” says Gupta.

“Meanwhile, the country has a very low penetration rate for consumer goods such as passenger cars, washing machines, refrigerators and air conditioners. With the low interest rates, more consumers can borrow and buy these goods. That is why the consumer discretionary sector is attractive at the moment.” 

Another reform taken by Modi was the demonetisation of all INR500 and INR1,000 banknotes to curb terror financing, black money and counterfeit currency. Gupta says that since the demonetisation last November, there has been greater demand for insurance and mutual fund schemes as cash transactions in other assets, such as real estate and gold, have become unattractive.

“This effort has been very beneficial for large insurance, asset management, and wealth management companies. Their assets under management have seen healthy growth, and they are also reporting very good earnings. Broadly speaking, this is the reason why we prefer the financial sector,” says Gupta. 

The well-performing Indian market, coupled with Manulife Asset Management’s extensive bottom-up research, has contributed to the outperformance of the Manulife India Equity Fund, he adds. The fund, which was launched in 2010, has outperformed its benchmark — the MSCI India 10/40 Index — and its emerging market (EM) peers since October 2014. 

According to Lipper data (as at Sept 29), the equity fund delivered returns of 21.87%, 64.45% and 121.89% over 12 months, three years and five years respectively. By comparison, the average return for the Global Emerging Markets Equity category was 25.26%, 47.63% and 66.16% respectively. 

Over the past year, the fund house has avoided sectors such as IT and healthcare due to their underperformance, says Gupta. “From our bottom-up research, we realised that the paradigm of IT is changing. People are moving to the cloud, so the demand for traditional IT companies will decline. 

“In healthcare, we realised that the prices of generic medicines are going down in the US, so Indian companies in that country will come under pressure. We have avoided these sectors and that has worked out for us.” 


Identifying opportunities

According to the Manulife India Equity Fund’s fact sheet, as at Aug 31, the fund had delivered a return of 97.74% since its inception. With a fund size of RM297.13 million, its top five allocations are in the financial, consumer discretionary, material, energy and consumer staple sectors. 

The equity fund started to outperform its benchmark in October 2014. This was due to the change in government in May that year and the fund house’s research expertise, which enables it to identify high-growth companies early, says Gupta.

The company has observed a lot of changes in the market, he points out, especially following the implementation of GST last July. It was reported that INR923 billion was collected from just 64.42% of the taxpayer base in the first month of implementation alone.

GST, coupled with better financial inclusion, will lead to a new normal for the Indian market, says Gupta. “For the longest time, India has been dominated by informal businesses with low productivity and efficiency. These businesses do not pay taxes or have access to formal credit. This will change in the near future. We will see a new normal where businesses get more efficient and start paying taxes. 

“Once they start doing that, the gross domestic product will improve and the government will get more revenue and start looking at spending. This transformation will continue to change the market over the next 24 months and we believe this will indirectly benefit our fund.” 

In the next year, the opportunities lie in companies in the formal sectors, which will receive larger market share due to the reforms, says Gupta. “Small companies in the informal sectors will find it difficult to adapt to the new normal in the next few months. They can no longer avoid paying taxes and will have to report their transactions. While the informal sector goes through these adjustments, the formal sector will take in more market share.

“What will happen is that the market share that used to go to informal and fragmented companies will now go to the organised sectors, such as organised retail, apparel, jewellery, logistics and electrical. This is one big theme that has started and will continue to play out in the next 12 months.”

At end-September, the Manulife India Equity Fund’s top five holdings were Housing Development Finance Corp Ltd (5.14%), ICICI Bank Ltd (4.88%), HDFC Bank Ltd (4.73%), Maruti Suzuki India Ltd (4.46%) and Reliance Industries Ltd (4.18%). 

It has large holdings in financial companies because new markets are opening up in the sector, especially as banks start to leverage data analytics and other technologies. “HDFC Bank is a prime example. It has grown its loan book on the back of better consumer demand and lower costs due to digitalisation,” says Gupta. 

Maruti Suzuki, which controls nearly half the automobile market in India, is growing market share as it benefits from the low penetration rate in the country. Reliance Industries is an energy stock that has performed well, thanks to the global economy, which has been supportive of material, energy and commodity stocks. 

Manulife Asset Management will not only avoid the IT and healthcare sectors but also telecommunications as there is currently a lot of speculation in the market. Gupta says the company does not expect a significant change to its strategy in the next 12 months as it is still betting on the beneficiaries of the Indian government’s reforms.

“We also do not have any target returns. The idea is to keep on investing in good companies and the returns will follow. That said, if I look at the blended earnings growth rate of all the investee companies in our portfolio, the companies should keep growing. If the valuation multiples are right, then it should be a fair expectation that the returns will be in line with the earnings growth,” says Gupta.

“In EMs, it is all about growth. We do not go for value alone. We have to identify the opportunities and companies that generate good cash flow, apart from making sure that we are buying them at a reasonable valuation. That is why I believe the fund is outperforming and giving decent risk-adjusted returns.”