This week’s interview from FundCalibre hears from Mithran Sudhir, client portfolio manager of the Goldman Sachs India Equity Portfolio fund, discussing the implications of Prime Minister Modi’s potential third term on Indian equities and the future prospects for investing in India’s dynamic market.
Why you should listen to the interview: Mithran offers an excellent overview of the Indian economy in this interview, offering insights into the trends that he believes will drive the Indian economy to even greater heights as well as discussing how he intends to capitalise on them for the fund.
This interview was recorded on 17 May 2024. Please note, answers are edited and condensed for clarity. To gain a fuller understanding and clearer context, please listen to the full interview.
Interview highlights:
Where are we with the elections as we sit today?
“We aren’t political analysts, but clearly we do have a base case which is that the status quo that we’ve seen for the last 10 years continues. Essentially you have a single party majority under the Bharatiya Janata Party, which is, I think, what most market participants have come around to.
Obviously any deviations from that could result in some kind of market moves, either on the upside or on the downside. If you end up in a scenario where there’s potentially policy paralysis where you’ve got a hotchpotch coalition government, I think that could result in momentum potentially slowing down and then obviously the multiple could correct in that scenario.
“However, let’s not lose sight of the fact that Indian corporates have delivered double-digit earnings growth over 30 years, annualised, irrespective of which government has been in power. Our base case scenario and overwhelming majority of market participants expect this continuity of reformist government which I think has served investors and the broader populace quite well for the last decade.”
The reforms and their benefits for the economy
“The ‘Make in India’ programme has seen a huge change in the way India operates. India has strong competence on the services side of exports, but has clearly under-delivered on the manufacturing side historically. We’re now seeing a concerted effort to enhance the manufacturing base within the country. Specific reforms that encourage manufacturing include, the implementation of a nationwide goods and services tax, the streamlining of labour laws, significant corporate tax cuts that have been passed in the last few years and enacting a strong bankruptcy code. All of these have improved ways of doing business in India.
“On top of this, the government has put in place production linked incentives within certain industries aimed at localising production. It’s already quite successful, for example, with smartphones: around 10% of iPhones are made in India every year now compared to three or four years ago when really it was non-existent. The ambition for growth of that production from India is also quite significant.
“And the whole supply chain has now come in; a lot of the assembly work has now come to India, but you still need the components coming in from outside which is the next leg of the journey where you start localising more of the value add in the country. So, I think it really is a broad push for manufacturing that’s playing out within the country.
“Crucially, it happens at a time when multinationals have actively tried to now diversify out of this reliance that they had historically developed on China. I think moving to this ‘China Plus One’ sourcing model has clearly meant that this take up for Indian incentives and the push for manufacturing has been quite strong.
“Obviously, the benefit for the economy is manifold: you could see job creation pick up, you could see productivity gains coming through, moving percentage of population in rural areas within agriculture into manufacturing and higher value-add. You will also see other benefits like the current account deficit for the country narrows because you’re not spending as much money importing smartphones.”
Is the Indian stock market overvalued?
“All good things come at a price! It’s hard to argue that the Indian market is cheap, but clearly there are good reasons. For example, it’s always traded at a premium to broader emerging markets and we think it’s warranted, given India is a stronger-for-longer growth asset class; it has structurally higher returns and equity than other parts of EM as well as most other parts of the world. It has lower state ownership compared to other emerging markets as well as better sectoral diversification versus other emerging markets so we think India’s premium over emerging markets is certainly well warranted.
“India is currently trading at a premium to its own history but we take confidence in the above historical average earnings growth which is also above the global and emerging market average. This, coupled with the fact that it’s not a rebound story but one that where well-entrenched growth is playing out, we feel is a positive indicator that India will grow at similar levels next year versus some of the other markets. Given all of these aspects, we are fairly confident in the economy.
“The final point is the fact that if you had entered this market at similar valuation level and held on up until today, you would have seen double-digit market returns in all of those scenarios because the multiple has cancelled itself out and you’ve had double-digit compounded annual earnings growth. I think that’s the beauty of the Indian market and I think that’s really what you’re buying with this valuation entry point.”
Key, long-term growth sectors
“The financial sector has definitely been a high conviction idea for our portfolios for a long time now. On the banking side, we generally favour private sector banks. We are structurally underweight state-owned banks and that’s a trend that continues.
“Banking is at a fairly interesting point because you’re seeing strong asset quality, housing affordability is improving, the CapEx cycle domestically is clearly picking up. And as we’re seeing broader interest rate pressures outside the country as well in the West begin to subside, you should see borrowing costs ease and I think the uptake for credit will continue to pick up. It’s still a slightly under-penetrated segment, so there is a long way for growth and private sector banks continue to gain market share from their state-owned peers. So, for us, this is a long-term growth segment for us.
“On the non-banking side, this segment has really boomed in recent years. You think about under-penetrated segments like insurance, stock broking, asset and wealth management, stock exchanges, SME lending or the broader kind of FinTech complex with a number of these changes that are happening with online payments and the ubiquity of mobile phones and mobile transactions. These are really segments where you’re seeing market leaders emerge and come into the public markets for the first time. These are mostly small-cap names and I think that abundance of new ideas is really something that’s quite exceptional.
“Hence I would say both in the banking space with some of these private sector banks and in the non-banking finance space with these grossly under-penetrated segments, we are really seeing huge opportunities play out in the financial space in India.”
Conclusion
If you’re looking to boost your emerging market allocation, then this interview gives a great introductory overview of where the investment potential in India lies. Mithran delves into the key trends for growth as well as exploring the opportunities available in the small and mid-cap sector. He also discusses the completely new product categories that have come to market in India in recent years, offering “fertile ground for active managers like ourselves”.
