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How global investors view the Indian stock market

Posted by: Uma Shashikant on Oct 02, 2017, 10.13 AM IST

Investment clubs have been a popular concept for quite some time. The idea is for a group of involved investors to analyse stocks and make investment decisions collectively. Each member takes on the responsibility of coming up with an investment idea, discussing the merits with the group, doing the necessary calculations and making a case for it. The ideas are then put to vote, and the club invests in the ones that are approved. The entire process is documented.

Recently, an investment club in Atlanta made up of 21 women invited me to observe and facilitate their discussion about investing in India-focused ETFs. They have been making collective decisions for 26 years now. They had their formats and process, and mostly invested in stocks directly. They came around to the view that they would have to buy ETFs if they wanted an India exposure and the entire team worked on the idea before the meeting. It was interesting to observe how outsiders view our markets.

Why should an US-based investor invest in India, some asked. The US has the largest market cap in the world, and dominate the global equity markets. India accounts for too small a percentage of the global market cap. While emerging markets as a whole, represent a large percentage of world GDP and population, and also account for a significantly higher GDP growth rate, isn’t the investible universe very small? Further, aren’t the companies too small from a global perspective? The top four companies listed in the US have a total market cap that is higher than the entirety of the Indian markets’. So will investing in the Indian market mean holding too many stocks?

The basic case for a global investor to invest in Indian markets is the benefit that an exposure to emerging markets can provide. These are markets that grow at a high rate, and offer opportunities that developed markets may not. But to a US investor, there is a consistent stream of new businesses coming in as investment opportunities. The investment club in question is one that has made eye-popping returns from Apple and Google. Therefore, Indian equity is attractive only when it offers something that a developed market would not.

For instance, to these investors, the Indian banking sector represents the ability of modern and technology-driven firms to capture the opportunities offered by a large population which still does not use credit significantly. The Indian pharma sector represents the ability of new firms to take on established drug manufacturers, patent new drugs and compete in the global market. 

However, the optimism offered by the numbers is dampened by qualitative research that the members do when they consider an investment case.

One of the members had studied the banking sector and was of the view that non-performing assets are a bigger problem than the government has acknowledged. They also noted that given the sectors that seem to be defaulting, large private sector banks also have an exposure, although smaller than that of public sector banks. 

The member that looked at the pharma sector was very worried about the adverse reports about quality and data rigging scandals at some Indian pharma companies. She was alarmed by the faulty processes in place for reporting lab test results. She had also read excerpts from Indian and foreign institutional investors’ research reports that laid a lot of emphasis on the quality of management. She worried that as a foreign investor, she wouldn’t know if the management could be trusted to have ethical practices.

There was not much euphoria about the IT sector, the poster child of Indian industry when it comes to global investors. They liked the historical growth, profits and cash flow numbers. But their primary question was about why all the IT majors have converted themselves into body-shopping outfits, when they could have stood out as innovative solution and service providers. They did not see much of an upside in a sector that did not seem to do anything new or exciting. 

The members noted that almost 50% of the large-cap indices tracking the Indian markets were represented by financial services, IT and pharma. They concluded that investing in the Indian market would mean taking an exposure to these sectors.

What they found intriguing was that the large-cap indices held too many traditional businesses: cement, metals, construction, energy, heavy engineering and the like. Their view of the companies in these sectors was that these were old-style businesses with a steady revenue, but with lower margins. They also faced a higher risk of being too slow to change. 

The members of the club were unanimous in their worry that if they invested in a Nifty based ETF, the dominance of few companies and sectors would mean that the returns would be volatile. The presence of a mix of modern and traditional businesses would mean that the returns would get averaged down, even if the new sectors began to boom. They opined that all indices would have this limitation by default.

The members of the club were unanimous in their worry that if they invested in a Nifty based ETF, the dominance of few companies and sectors would mean that the returns would be volatile. The presence of a mix of modern and traditional businesses would mean that the returns would get averaged down, even if the new sectors began to boom. They opined that all indices would have this limitation by default. 

Among the three ETFs that they had shortlisted, one had 54 holdings, mostly mimicking the large-cap index. Another had a mix of large and mid-cap holdings, spread across 74 stocks. The third had a mid-cap focus with some exposure to large-cap, holding 248 stocks. 

They dropped the third one merely for its number of holdings. Even if something did spectacularly well, it wouldn’t matter to the performance of the ETF as its weight would be too small, they agreed. Also, who could manage such a large number of stocks efficiently? Between the two others, they preferred the ETF with a mix of small and large caps, primarily because there was no other way to get exposure to Indian mid-caps, which is a story that is strongly pitched to all global investors. 

Their conclusion was that investing in India was not an investment in value or dividend, but in growth and momentum. But the size of the exposure cannot be large, given the small size of the market itself. The cyclical risks were high, as the Indian markets would swing in tandem with other developed markets, but the structural gains were significant, given that the markets offered opportunities that were unique. They set their 10-year return expectation at 8% to 9% per annum, and voted in favour of investing in the opportunity. 

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