FSSA Discovering India - the rising jewel of Asia

Our different perspectives

As a team, FSSA has been investing in India since the market first opened to foreign investors (in the early ‘90s); we then launched our dedicated India strategy in 1994. In the decades since, it has been one of our favourite markets to invest in.

First, we have a positive view on the composition of the equity universe. In India, the majority of businesses are family-owned, who take a long-term view on the future of the company. Our alignment, as long-term shareholders, is much more direct and clearer in these cases. With such long track records, there is ample evidence of their behaviour towards stakeholders – especially during more challenging periods – and how it has evolved over time. Second, earning high returns on capital has always been a focus for Indian companies, because of the capital constraints. This is reflected in the weighted average return on capital employed (ROCE) for the FSSA Indian Subcontinent strategy, which is a healthy 39% (as at 30th June 2024).7 That is not always the case, especially in countries where the economy is state-directed. In those countries, if the government decides to build roads, infrastructure or renewable energy, capital availability isn't an issue. This tends to mean lower returns for state-owned enterprises. In terms of the opportunities – India’s allure as an investment destination is underpinned by 1) its large population of young and aspirational consumers spending more on goods and services; and 2) the prevalence of large companies hiding in small market capitalisations. For example, with rising per-capita incomes, Indian consumers are spending more on discretionary products. This benefits companies such as Blue Star, one of the leading air-conditioning brands in India. Blue Star has gained market share consistently over the last decade by introducing new models and expanding its distribution. But its market capitalisation is just USD 5.2bn8 – a relative minnow when compared to the equivalents in, say, China. Another example is Colgate-Palmolive (India), which has been present in the country since 1937 and has a dominant position in India’s oral care industry. Per-capita consumption of toothpaste in India is half of that in other developing countries, and average selling prices are substantially lower as well. As incomes rise, we believe consumers will upgrade from basic formulas to premium versions – what we call the “premiumisation trend”. Given that the Colgate brand has more than a 50% share of the Indian market9 and strong pricing power, profitability should improve over time.

What are your views on India, in terms of its fundamentals and the investment opportunities?

What are some of the risks investing in India?

One of our key concerns is the level of economic concentration in the market. We like the fact that India is such a broad and deep market to invest in. But in recent years, some groups have been growing aggressively. If these companies start to suppress competition, the market could become less deep and less broad. Plus, the median market valuations for India will derate quite sharply. We also worry about the environmental risks. Some of the most polluted places in the world are in India. If India does not manage its environmental and social risks properly, this will eventually have an impact on growth. Taking automobiles as an example, Delhi imposed a temporary “odds and evens” scheme– a traffic rationing measure which restricts the vehicles on the roads based on the last digit of its registration number. And the government will halt car sales if pollution keeps rising. Another big risk to India is automation. India has a large population of 1.4 billion people10, with several million new graduates every year. But when a company sets up a new factory today, they need just half or even one third of the labour compared to 10 or 15 years ago. With such huge numbers entering the labour force, if there aren’t enough employment opportunities there could be widespread social unrest. Conversely, one thing we don’t worry about is the politics aspect. India has had many different governments over time, some of which have lasted two weeks to over 10 years. Despite all the political complexities, India has continued to evolve and move forward. Quality businesses have also performed well in the long run – and this is despite the politics, not because of it.

What are some of the risks investing in India?

How do you mitigate the impact of the Indian rupee’s depreciation on the portfolio?

We do not try to predict how the Indian rupee will perform in the future. Instead, we look for companies and management teams that have an established track record of dealing with macroeconomic changes – including currency fluctuations and interest rate movements – and are still able to grow the business sustainably. Often, a challenging environment is a boon for the best-managed companies, as the strength of their brand allows them to gain market share at the expense of the weaker players. Over the last 30 years, the Indian rupee has depreciated by more than 90% against US dollar.11 But total shareholder returns for companies like HDFC Bank, Nestle India, Unilever, and a number of other companies in our portfolios, have been more than 20% in USD terms on an annualised basis – even allowing for the sharp depreciation in the rupee. This is because these companies are dominant in their respective categories. Not only are they resilient, but they typically gain market share during difficult periods. We believe good companies will have the pricing power to overcome this currency devaluation. Quality companies often have strong balance sheets and conservative management teams, and typically demonstrate stronger performance than peers during tough periods. Nestle India is a good example. It has more than 90% market share in infant milk formula.12 As the rupee depreciated, raw material prices went up. But because Nestle is dominant in certain consumer categories, the company was able to pass that cost on to its customers. As input prices fall, Nestle's margins have improved gradually – and continue to expand – as it can keep its selling prices at the same level.

How do you mitigate the impact of the Indian rupee’s depreciation on the portfolio?

What are the team’s views on India’s rich valuations?

While there are some frothy valuations in pockets of the market, that is not true for the entire market. For instance, the weighted average 12-month forward price-to-earnings (P/E) ratio for the FSSA Indian Subcontinent strategy is 27.9x (as at June 2024). When measured against its own history (5-year average of 22x P/E), this does not seem overly concerning. The portfolio’s weighted average return on capital employed (ROCE) of approximately 40% and anticipated 2-year earnings growth of 13% compound annual growth rate (CAGR) should also be supportive in the medium term.

What are the team’s views on India’s rich valuations?

Why complement an existing Asia, Global Emerging Markets (GEM) or China exposure with an allocation to India?

While allocating capital to a regional strategy is a reasonable thing to do from a diversification standpoint, we would argue that the best-performing parts of the strategy are diluted (just like a portfolio with too many stocks). For example, when we look at the top contributors to performance of the FSSA India Subcontinent strategy over the past decade, companies like Eicher Motors and Blue Star feature prominently. But these Indian companies are not typically owned in regional strategies. Instead, what one gets, in terms of the exposure to India via regional funds, are usually large companies which are actively traded. These tend to be a bank, an IT services company and maybe a consumer staples company. They have kept up with the market, but in our view, they are not the ‘best’ businesses to own in India when we look ahead at the next 10-20 years. We believe the really attractive businesses are still not yet on the radar of regional investors. Hence, an allocation to a dedicated India strategy makes sense.

Why complement an existing Asia, Global Emerging Markets (GEM) or China exposure with an allocation to India?

What are we doing differently compared to peers?

As a team, FSSA has been investing in India since the market first opened to foreign investors in the early 90s; we then launched our dedicated India strategy in 1994. Meeting companies is at the core of our investment approach, as we believe we can gain valuable insights from questioning the management about their long-term strategy. We take a long-term view on investing – of at least five years but often much longer. We have owned most of our core India holdings for more than a decade. We make five to seven trips to India every year and meet with about 250 Indian companies. On these trips, we spend our time identifying the right people to back – we like to own family-owned businesses with strong management teams who can build successful and sustainable businesses in the long run. In addition to engaging with management teams we also conduct checks on the people and the business. But rather than building complex spreadsheets to predict a company's future, we consider how they treat minority shareholders and other stakeholders, and whether we are aligned with the company’s goals. We pay attention to what kind of governance structures they have, what the board looks like, whether there is enough independence, and whether the family board members are overly active. When we invest in companies, we are also very clear about the types of companies we will not invest in. For example, we have never invested in two of the largest business groups in India, because of the way they were built and managed, and how they influenced policymaking to their advantage. When we engage with companies, we are not necessarily looking for them to agree with us. Instead, we want to gauge whether they are open to engagement from a stakeholder, or dismissive of it. Generally, we have found that our portfolio companies are open to our suggestions and take a long-term view on environmental, social, and governance (ESG) issues. They want to do the right thing for their community, as they will be based within these communities for the next 20, 30, 40 years. We have spent the past decades building relationships with high-quality owners and managers in India and have identified, in our view, some of the best compounding growth opportunities in the world. The companies we own are in our view good businesses run by good people, who are returns conscious. They also exhibit good governance practices and are overseen by regulators who are getting better at doing the right thing for all stakeholders. With our portfolio of high-quality Indian companies, we are confident in preserving our clients’ capital during tough periods and growing it steadily over the long term.

What are we doing differently compared to peers?

India’s large population, its rapidly developing metropolises and its rich history of commerce, are all contributing to its journey in becoming an economic powerhouse. At FSSA Investment Managers, we have spent the past decades building relationships with high-quality owners and managers in India and have identified, in our view, some of the best compounding growth opportunities in the world. With high governance standards, strong investor protections and a longstanding culture of equity ownership, we have always found reasons to be excited about India.

Eyes on India’s attractive growth opportunities

As one of the fastest growing economies in the world today, India is capturing the attention of global investors. But irrespective of its current favour, we have long been excited about the growth opportunities this market presents.

The FSSA Indian Subcontinent strategy was launched in 1994 – an early investor into India, post-reforms.

Our insights

Reflections on investing in Indian equities over the past 20 years

Vinay Agarwal, Director of FSSA Investment Managers, has more than 20 years of investment experience. The team has spent decades building relationships with high-quality owners and managers in India and have identified, some of the best compounding growth opportunities in the world. Read on as he shares the experiences and some of his reflections over the past decades.

Vinay Agarwal • 5 November 2024

Article

Weighted Harmonic Average Trailing P/E for the FSSA Indian Subcontinent Strategy (VCC). These figures refer to the past. Past performance is not indicative of future performance. For investors based in countries with currencies other than USD, the return may increase or decrease as a result of currency fluctuations. Source for FSSA Indian Subcontinent performance: First Sentier Investors. The performance data is calculated on a total return basis and gross of tax. Source: FSSA Investment Managers, as of July 2024.

Read more about our India strategy

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7 Source: First Sentier Investors 8 Source: Bloomberg, as at 30 September 2024 9 Source: Company materials

10 Source: World Bank Databank, as at 2023 https://data.worldbank.org/indicator/SP.POP.TOTL?locations=IN

11 Source: Bloomberg, as at 30 September 2024. 12 Source: Company materials

Source: Company data retrieved from company annual reports or other such investor reports. Financial metrics and valuations are from FactSet and Bloomberg. As at 30 September 2024 or otherwise noted.

Evolution of the Indian stock market

Despite the challenges, India’s equity market has been resilient in the long run. Click on the market events to learn more.

Domestic investors (including both institutional and retail) account for approximately 25% of the stock market, while foreign institutional investors make up 17% of the market. The rest of the market comprises private promoters (41%) and government-owned promoters (11%).3

Today

Emerging from the depths of Covid lockdowns, Indian equities were among the best-performing markets in Asia in 2023 and 2024 to date.2

2024

After recovering from the GFC, India faced a series of challenging events that affected domestic demand. The early part of the decade was marked by various scams and corruption scandals.

2010s

The Indian economy was booming, with gross domestic product (GDP) growing by around 8% a year between 2003-07.

Mid-2000s

Almost 10,000 companies were listed across 23 stock exchanges in India. Total turnover for the year reached INR29 trillion (approximately USD600 billion using 2001 exchange rates)1.

2001

The Indian stock market exploded with initial public offerings (IPOs). However, many were launched by “fly-by-night” operators and huge frauds were committed.

Mid-1990s

The FSSA Indian Subcontinent strategy was launched.

1994

The start of a new era in the Indian mutual fund industry, with the formation of private-sector investment firms. The MSCI India index launched in the same year.

1993

The National Stock Exchange (NSE), which along with the Bombay Stock Exchange (BSE) comprises the two largest stock exchanges in India, was launched.

Foreign Institutional Investors (FII) could invest in Indian securities, subject to registration with SEBI and permission to trade from the RBI.

1992

The government implemented a series of structural reforms in efforts to liberalise the economy.

1991

1988

The Securities and Exchange Board of India (SEBI) was established to regulate the Indian stock market, the mutual fund industry and financial intermediaries.

Other public-sector banks and life insurance companies started launching mutual funds.

1987

1977

Reliance Industries listed its shares on the stock exchange, which were heavily oversubscribed by domestic retail investors. Thus began the “cult of equity ownership” in India.

Unit Trust of India (UTI), a public sector investment arm established by Parliament and set up under the Reserve Bank of India (RBI), launched India’s first mutual fund, Unit Scheme 1964.

1964

1874–75

Bombay Stock Exchange (BSE), the oldest stock exchange in Asia was established

2010s

While his reforms (e.g., demonetisation, GST) initially led to a slowdown in the economy, as the unorganised sector struggled, the longer-term result was a cleaner operating environment and stronger performance for the kinds of companies we invest in.

2011 – Telecom scam, Coal scam, Commonwealth games corruption 2012 – Anti-corruption movement 2013 – Narendra Modi elected PM 2016 – Demonetisation 2017 – Introduction of Goods & Services Tax 2018 – Collapse of IL&FS, Dewan, and Yes Bank 2020 – Covid-19

Mid-2000s

The Indian economy was booming, with gross domestic product (GDP) growing by around 8% a year between 2003-07.  The Indian stock market went from strength to strength, as real estate and infrastructure investments helped boost the market to new highs – until the Global Financial Crisis (GFC) hit in 2008.

1991

India faced a balance of payments crisis and currency reserves fell to a historical low. In response, the government implemented a series of structural reforms related to the financial sector, foreign exchange and international trade in efforts to liberalise the economy.

1874–75

Brokers traded stocks and shares at Dalal Street in Mumbai (“Dalal” means “broker” in Hindi), which became known as the city’s financial district, similar to Wall Street In New York. This group formed the Bombay Stock Exchange (BSE), the oldest stock exchange in Asia.

trillion

Mcap-to-GDP ratio at 154%

When India’s mcap first hit* ($trn)

154

269.50

22.7

21 May 24

120

277.65

23.3

29 Nov 23

198.30

110

29.8

25 May 21

12 July 17

157.61

24.5

29 May 07

20.4

41.64

Date

P/E* (x)

GDP at market price* (₹trn)

Mcap to GDP (%)

* On closing-basis

India’s market cap-to-GDP ratio (on a trailing 12-month GDP basis) is now at 154 per cent compared to 120 % in November 2023, when it first hit the $4 trillion mark.

Mcap-to-GDP ratio at 154%

73 953

66 902

50 638

31 805

14 508

29 May 07

12 July 17

25 May 21

29 Nov 23

21 May 24**

80 000

60 000

40 000

20 000

Sensex Level

When India’s mcap first hit* ($trn)

* On closing-basis

** On intra-day basis according to BSE website, Sources: Bloomberg, BSE

4 https://www.business-standard.com/markets/stock-market-news/market-cap-of-bse-listed-companies-hits-5-trillion-first-time-ever-124052101387_1.html

Today

BSE data showed India’s mcap crossing:

A jump of 62% from March 2023 lows.

India’s stock market capitalisation milestones:4

swipe for more

3 https://www.livemint.com/market/stock-market-news/mutual-funds-retail-shareholding-in-indian-stock-market-at-record-high-fii-stake-slips-to-12-yearlow-11724139544269.html

Consistently improved governance standards

Owners and management teams who are receptive to engagement and focused on returns

Large businesses hiding in small market capitalisations

One of the oldest equity markets globally

Large universe of high-quality listed companies

Consistently improved governance standards

Our experience of investing across emerging markets suggests that India is ahead of peers when it comes to protections for minority shareholders. Whether it is the tag-along rights in the case of an acquisition, approvals for related-party transactions, mandatory independence rules for boards, mandatory disclosures of shareholdings and pledges, etc., India’s regulatory system is among the strongest in the region and has consistently improved over the years.

India has always been capital starved, with relatively high interest rates in general. Generally, this has meant that the best-managed Indian companies are very aware of the cost of capital and its constraints, and typically operate with high returns on capital employed (ROCE). We have found that it is possible to have meaningful conversations with management teams about capital allocation in India. We also discuss issues like board independence and effectiveness, remuneration policies, succession, quality of financials and related-party transactions – all of which tells us a lot about the culture of a company and helps us develop conviction in our holdings.

Owners and management teams who are return-on-capital conscious

Large businesses hiding in small market capitalisations

The sheer scale of India’s population combined with the still nascent stage of several industries means that the market leaders are quite small in comparison to regional and global peers. This implies there is plenty of room for growth. For example, China has an estimated 860 million air conditioners installed versus 80 million in India (2023 figures).5 The top three listed air conditioner manufacturers in China have a combined market value of USD 144bn, whereas the top listed companies in India are tiny in comparison – Blue Star, for example, a leading player with 13% industry market share, is just USD 5.2bn.6

One of the oldest equity markets globally

India’s Bombay Stock Exchange was established in 1875, making it among the oldest in Asia. The culture of entrepreneurship, and the ability to deal with the opportunities and challenges that come with being a public listed company, has been in place for many decades. As a result, there is an abundance of high-quality family-owned business that are listed – it is not uncommon for a public company in India to have more than 50 years of listed history and is now being managed by the third or fourth generation of family members. We like these family-owned firms because they take a long-term view about the future of their business.

Large universe of high-quality listed companies

Out of more than 6,000 listed companies in India, the FSSA team has met with and analysed a wide range of businesses. From these, we invest in a relatively small number of companies that meet our standards of quality (in terms of ownership, management, alignment and business franchise). These quality Indian companies come from a variety of industries, unlike various commodity-driven emerging markets where certain sectors are simply absent from the stock market. There is also a large home-market to exploit, which means Indian companies are not overly reliant on export demand.

What makes India an exciting investment destination

Vinay Agarwal, Director at FSSA Investment Managers, provides his unique perspectives on where he is finding attractive growth opportunities amidst the development and formalisation of the Indian economy.

2 Source: Bloomberg, MSCI, as at 31 August 2024.

1 Calculated using Oanda.com, as at 31 December 2001

Source: IEA, Global air conditioner stock, 1990-2050, IEA, Paris https://www.iea.org/data-and-statistics/charts/global-air-conditioner-stock-1990-2050 , IEA. Licence: CC BY 4.0

Source: Bloomberg, as at 30 September 2024.

Shining with growth opportunities for long-term investors

Discovering India - the rising jewel of Asia

Our insights

Our different perspectives

Exciting investment destination

Stock market evolution

1874–75

1991

Mid-2000s

2010s

trillion

Mcap-to-GDO ratio at 154%

When India’s mcap first hit* ($trn)

154

269.50

22.7

21 May 24

120

277.65

23.3

29 Nov 23

198.30

110

29.8

25 May 21

12 July 17

157.61

24.5

29 May 07

20.4

41.64

Date

P/E* (x)

GDP at market price* (₹trn)

Mcap to GDP (%)

* On closing-basis

India’s market cap-to-GDP ratio (on a trailing 12-month GDP basis) is now at 154 per cent compared to 120 % in November 2023, when it first hit the $4 trillion mark.

Mcap-to-GDO ratio at 154%

73 953

66 902

50 638

31 805

14 508

29 May 2007

12 July 2017

25 May 2021

29 Nov 2023

21 May 2024**

80 000

60 000

40 000

20 000

Sensex Level

* On closing-basis

** On intra-day basis according to BSE website, Sources: Bloomberg, BSE

When India’s mcap first hit* ($trn)

4 https://www.business-standard.com/markets/stock-market-news/market-cap-of-bse-listed-companies-hits-5-trillion-first-time-ever-124052101387_1.html

Today

BSE data showed India’s mcap crossing:

A jump of 62% from March 2023 lows.

India’s stock market capitalisation milestones:

Watch the team’s reflections on the evolution of the market, and learn about how we invest in India.

Our long-term track record of investing in India

Amidst these challenges, Narendra Modi was elected PM.

2014

These figures refer to the past. Past performance is not a reliable indicator of future results. For investors based in countries with currencies other than USD, the return may increase or decrease as a result of currency fluctuations. All performance data for the FSSA Indian Subcontinent Strategy Class I (Accumulation) USD. Source for Strategy - Lipper IM / First Sentier Investors, as at 31 October 2024. Performance data is calculated on a gross of fees basis. Source for benchmark – MSCI. *Benchmark since inception to 01 July 2016: MSCI India Index gross. From 01 July 2016 to date: MSCI India Index net. Strategy and benchmark includes income reinvested net of withholding tax. Since inception performance figures have been calculated from 23 August 1999.

India's growth opportunities

Watch the team’s reflections on the evolution of the market, and learn about how we invest in India.

Our long-term track record of investing in India

These figures refer to the past. Past performance is not a reliable indicator of future results. For investors based in countries with currencies other than USD, the return may increase or decrease as a result of currency fluctuations. All performance data for the FSSA Indian Subcontinent Strategy Class I (Accumulation) USD. Source for Strategy - Lipper IM / First Sentier Investors. Performance data is calculated on a gross of fees basis. Source for benchmark – MSCI. *Benchmark since inception to 01 July 2016: MSCI India Index gross. From 01 July 2016 to date: MSCI India Index net. Strategy and benchmark includes income reinvested net of withholding tax. Since inception performance figures have been calculated from 23 August 1999.

The Indian economy was booming, with gross domestic product (GDP) growing by around 8% a year between 2003-07.

Mid-2000s

Amidst these challenges, Narendra Modi was elected PM.

2014

2010s

The early part of the decade was marked by various scams and corruption scandals, then came demonetisation, the introduction of Goods & Services Tax (GST), the collapse of non-banking finance corporations and the Covid-19 global pandemic.