Goldilocks Economy: Road to $5 trillion
The Indian economy seems to be chugging along nicely with estimates from various sources estimating economic growth to be above the 7% mark this year and onwards as the transformational reforms under Prime Minister Narendra Modi bear fruit. There will, however, be some growing pains that will prevent growth from being a straight line, but this is to be expected. We maintain our bullish on the country and maintain our BUY rating on the Fidelity India Fund (ASX:FIF).
The latest GDP statistics from the Central Statistics Office (CSO) for the third quarter of fiscal 2017 (October – December) indicate that the economy expanded 7.2%, beating consensus expectations of between 6.5% and 6.9% growth. There was a strong overall recovery in the agriculture, manufacturing, and construction sectors.
Source: India Macro Advisors, Central Statistics Office
It was the economy’s fastest pace of growth in 5 consecutive quarters and has allowed the country to reclaim its status as the world’s fastest growing major economy, surpassing China for the first time since the implementation of the Demonetisation and the Goods & Services Tax (GST) gave the economy some hiccups.
In our previous coverage of India’s economy, we have noted that the transformational reforms were painful but necessary to fully realise growth potential. Recent developments indicate that the negative effects of the reforms appear to be largely over as the graphics below indicate:
Source: MOSPI, Focus Economics
India’s Industrial Production has recovered in recent months with manufacturing steadily climbing back as the GST troubles fade away. An interesting titbit shows that production of capital goods — a proxy for domestic fixed investment — was a major source of growth as it accelerated rapidly in February, up 20% year-on-year and outpaced the preceding month’s 12.8% year-on-year increase.
Another plus factor was that infrastructure output growth posted strong gains in February, supported by higher steel and cement production while consumer durable production also ticked up over the same time frame. Overall, Industrial Production for the month grew 7.1% year-on-year and beat consensus expectations of a 6.8% rise.
Source: IHS Markit, Focus Economics
Moving on, business sentiment has stayed positive as evidenced by the chart above where the composite Purchasing Manager’s Index (PMI) shows that both manufacturing and services were both above the 50-mark – indicating continued expansion – at 50.8 in March from last month’s 49.7.
According to the survey, purchasing activity across both sectors increased in March as firms raised inventories in response to new work orders and increased business confidence. Respondents in the survey also noted an uptick in their expectations of economic conditions and demand as the impact of GST last July has been fully absorbed.
It’s also worthy to note that the strong demand, based on increased order flow and mounting back logs of work, prompted numerous respondents to expand their respective hiring activities, with the Service sector showing its hiring rate hit the fastest pace in 7 years.
Going forward, international institutions from the Asian Development Bank to the World Bank already peg FY2018’s growth to be above 7.3% to outpace China’s estimated 6.6% on the back of strengthening private consumption, while negative effects of transition (GST & demonetisation) fade away. Over the longer term, India’s economy is expected to reach $5 trillion by 2025 – making it the largest economy in the Commonwealth and the 6th largest in the world.
With all these positives and our long-term perspective, it would be easy to lose sight of what’s in front of us (i.e. the near term). So, despite our bullish view, we do want to remind Members to exercise some prudence as many (but not all) of India’s listed equities are close to or already fully priced.  As a rough proxy, as at 23 April 2018, India’s market capitalisation-to-GDP ratio hovered at 90.1%.
That said, an alternative to individual stock picking in Indian equities, which isn’t practical for most international investors anyway, is the Fidelity India Fund (ASX:FIF) which combines a broad exposure (some 50 – 70 stocks) with a strictly bottom-up value investing approach providing members access to good companies at minimal risk.
Overall, India’s long-term story remains intact in our view. We retain our long-term bullish outlook for India and our positive view on the Fidelity India Fund, which rates well on our fund scorecard table (see below).
Fund Overview
Leadership & Management
The lead portfolio manager is Amit Goel who is the Portfolio Manager for the Fidelity India Fund (ASX:FIF) since 31 March 2016.
He is currently based in Singapore and also is responsible for the Emerging Asian Equities team. Mr Goel has been part of the Fidelity team since 2006 and started out focussing on the healthcare sector, before taking on a broader research analyst role in 2008 covering multiple sectors across the Indian equity market.
Despite Mr Goel’s relatively short tenure in the fund, we cannot attribute the longer track record of the Fund to the current manager.However, it is worth noting that the portfolio manager is backed by Fidelity’s Indian analyst research team,which collectively has a longer tenure. Overall, we give the Leadership & Management a solid rating, while at the same time acknowledging Fidelity’s depth and reputation.
Investment Approach
The Fund’s aim is to achieve returns in excess of the MSCI India Index over the suggested minimum investment time period of 5 to 7 years. To achieve this, the fund is benchmark aware and focuses on relative performance through a bottom-up stock selection approach.
Fee Structure
The Management Expense for the fund is 1.20% per annum, which includes administration costs and investment costs. The only additional cost is the buy-sell spread that is triggered when buying or selling units, which is 0.50% of the Net Asset Value unit price (i.e. buy costs are 0.50% of the NAV unit price and sell costs are 0.50% of the NAV unit price). There are no establishment, contribution, withdrawal or termination fees.
The Fund requires a minimum initial investment of A$25,000, there is no minimum for additional investments.
Application and withdrawals can be made every Sydney business day.
Portfolio Structure
The Portfolio itself reflects the Fund’s strategy and covers a portfolio of 50 to 70 Indian companies. There are portfolio guidelines for the Fund, as the Fund is relatively benchmark aware (versus the MSCI India Index).
In terms of stock positions, the Fund will generally be +/-5% around the weight of a stock in the index and has the option to hold cash with a target cash holding of between 0% and 10%. In terms of deviations from the benchmark Industry weightings, the Fund will usually be between +/-10% from index industry weightings. The Fund has no market cap or sector bias.
The Fund’s exposure is not hedged back to Australian dollars.
This means that the value of an investment in the Fund will change not only on the basis of a change in asset values, but also because of movements in exchange rates.
Performance
Moving onto performance, referencing the table below, we see that Fidelity India Fund (ASX:FIF) has maintained a long track record of outperforming the benchmark net of management fees in Australian dollars (versus the MSCI India Index). This is noteworthy given that the fund is not hedged.
Since inception (2005), the Fund has returned over 9.83% per annum, exceeding the benchmark’s 8.35% return and representing a relative outperformance of 1.48% per annum. A substantial portion of the outperformance can likely be attributed to the Fund’s analyst team which, collectively, has a much longer tenure compared to the Fund Manager, Amit Goel.
Over the 5-year and 7-year periods, the fund’s successful strategy of stock picking exemplifies the gap (4.41% and 3.32%, respectively) between the fund’s returns and the benchmark’s performance.
That type of time period is also our recommended holding period to allow the fund’s strategy to take full effect. We attribute this result due to the fund’s overweight positions in sectors (Consumer, Financials) benefitting more from the economic boom in the last five years.
Source: Fidelity Funds Website
Over the shorter term (i.e. a 1-year period) the gap between the index isn’t as wide , probably because the recent strength of the Indian economy has led to a broad rally, much like ‘a rising tide lifting all boats’.
Over the longer term, we do expect the gap to widen in favour of the fund given the overweight position in sectors that should disproportionately benefit from the long term structural economic trends.
Fund Outlook & Positioning
As such, we continue to see a focus on the long term with regards to the fund’s positioning. The sector allocation is set to benefit from the long-term effects of PM Modi’s reforms as well as ride the waves of India’s demographic transition where the middle class are quickly becoming a sizable force.
There will be growing pains that will affect the fund’s short term returns and therefore we recommend Members should hold this with a 5- to 7-year time horizon in mind.
Moving on to the Fund’s positioning, and as at 31 March 2018 the Fund maintained a significant exposure to Financials with a weight of 26.4% wherein our previous report (30 September 2017) it had a 25.5% exposure.
We also see that, relative to the benchmark, the fund has a 440-basis point overweight in the sector reflecting the fund manager’s view is that Indian banks will be beneficiaries of the reforms instituted by the RBI, as well as the growing ranks of the middle class which will lead to increased demand for banking services. In fact, current statistics point that 55% of new bank accounts opened globally are in India.
We concur with this view, and this is one tenet to our general positivity on the Indian banking sector.
Source: Fidelity Funds Website
Other sectors where the fund currently overweighs the benchmark is Industrials with an overweight of 220 basis points at 8.2%. Though this isn’t a significantly large exposure, relative to the other top allocations, and this factors in companies that are expected to suffer from the GST implementation. The Fund also attempts to ride the benefits of increased interstate trade post-GST with a slight overweight in Consumer Discretionary (+70 bps).
The following sectors are where the fund is underweight: IT (-420 bps), Energy (-310 bps), Materials (-240 bps), Consumer Staples (-340 bps), and Health Care (-240 bps). The cash position is around 5.3%.
Top 10 Holdings
Below, we take a brief look at some of the Fund’s current top-10 portfolio holdings as of 31 March 2018. The Fund remains very concentrated with almost half (47.6%) of its capital invested in the top 10 though the MSCI India Index also has a relatively concentrated portfolio at 46.22%.
Source: Fidelity Funds Website
Reliance Industries Ltd still occupies the 2nd spot with a weighting of 8.5% (previously 7.7%). The fund has a slight underweight relative to the benchmark by 15 basis points.
Reliance is one of the biggest India-based private sector companies with businesses across energy, telecom, textiles, and retail. The stock has recently been covered by our Asian Equities team (FAT-ASA-143) at the end of March, covering the 3Q18 earnings results.
Given the sheer size of the company and its reach across numerous sectors, we will narrow the focus on just the salient developments. The group, at the end of March sold off its Texas shale assets for $100 million to Sundance Energy and covered its oil wells of its Eagle Ford project.
This reflects the group’s move out of US shale investments which started in October 2017 when it sold a similar asset block located in Pennsylvania to BKV Chelsea for $126 million, or 1/3 of its acquisition cost (in 2010) as the recent downturn in oil prices had made operations uneconomical for the company. That said, the company only has 1 more US shale asset left and we believe it is still looking for buyers.
Although Punjabi automobile manufacturer Mahindra & Mahindra is the 8th largest position in the fund, it is not this positioning that caught our eye. The company has been underperforming and losing ground to competitors like Tata Motors but recently has made a comeback with a growing commercial vehicle business and strengthening tractor business.
The stock has also recently released its 4Q 2017 earnings results that significantly outperformed consensus estimates. The key takeaways are the following:
(i) solid revenue growth (+22% yoy) to ₹16.2 billion with sales to Europe (EU) up 24% year-on-year. (ii) EU margins expanding sharply 150 basis points ahead of consensus to 14.8%. (iii) consolidated (adjusted) EBITDA came in ₹2.4 billion, up 15% quarter-on-quarter and beating the consensus estimate by 23%. (iv) growth likely to accelerate with the acquisition of Bill-Forge (component manufacturing) and large orders from EU.
Provided this growth trajectory continues, we may look at this company specifically for our Asian portfolio.
Summary
India’s economy in the 3Q grew at a faster than expected pace of 7.2% as numerous sectors registered robust growth. It was the country’s strongest GDP performance in the last 5 quarters and the pace surpassed China’s growth.
Going forward, our expectations remain positive on the back of rising incomes, favourable demographics, strong consumer spending, and an accommodative government which should keep the country’s annual growth rate above 7%.
Accordingly, Fidelity India Fund (ASX:FIF) will remain held in the Fat Prophets Portfolio. We recommend the Fund as a buy to Members without exposure.
Disclosure: Interests associated with Fat Prophets hold an interest in the Fidelity India Fund (ASX:FIF). HDFC Bank and Reliance Industries are held in the Fat Prophets Asian Equities and Global Opportunities Model Portfolios as well as the Fat Prophets Global Contrarian Fund.
