Two interesting phenomena in India have captured interest from around the world over the past several months.
The first is the dichotomy between India’s macro and micro signals, and the second is the outsized role of a few stocks in driving the stock market. Both offer insights as to why selectivity is essential in investing in India’s equity market.
Disconnected macro and micro signals
In recent years, India has enjoyed good macro conditions primarily led by subdued inflation, lower interest rates and commodity prices (especially for crude oil), a manageable current account and an appreciating currency.
Despite the positive macro backdrop, the micro — or the health of many Indian companies — had room for improvement, with many companies suffering from high leverage and low demand for their products. Challenging micro aside, the equity market (represented by the MSCI India Index) rose nearly 39 per cent last year. This surge was largely fuelled by domestic and foreign flows chasing good macro, but ignoring the deteriorating micro environment.
The dichotomy between macro and micro remains this year, but we are seeing a shift. The good macro story has deteriorated, while the micro environment has improved considerably. Indian companies are moving forward, and demand is returning.
Here are some of the positive trends that PineBridge has identified:
- Unprecedented orders witnessed in the infrastructure sector. These have been for roads, housing (positive for the cement sector), electricity generation, and others. For example, the road sector received nearly US$20 billion of awards for new roads, while the housing sector is seeing the implementation of a US$35 billion urban housing construction project. Increased demand is also visible in the order books of industrials, especially engineering companies and in consumer sectors.
- Bankruptcy proceedings are progressing. The resolution of bad loans should free up capital that can be recycled back into the economy.
A market driven by a few stocks
The rise of the market last year may have given an impression that the equity rally was broad-based, since 89 per cent of the index companies contributed positively to the MSCI India Index’s returns.
But a closer look at the details shows that one quarter of the index’s returns came from just three companies, which together, represented one-fifth of the index’s weight. In short, flows replicated the index. And a few heavy weights, irrespective of their fundamentals and valuations, moved the market.
Despite an improving micro environment this year, the market has fallen into negative territory largely due to unfavourable macro news.
When we examine returns, we can see a similar pattern but in the reverse. This time around, only 28 per cent of the index constituents contributed positively to the index’s returns. Almost half of the 9 per cent positive return was generated by only three names with a quarter weight in the index.
In other words, 72 per cent of the index constituents pulled down the index by more than 10 per cent. The market is still driven by a select few stocks. And the movement is not broad-based.
Source: Bloomberg, as of 31 July 2018. Benchmark is MSCI India Total Return Index and the benchmark is used for illustrative purposes only, and any such references should not be understood to mean there would necessarily be a correlation between investment returns of any investment and any benchmark. An investor generally cannot invest in a benchmark. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
The good news for investors is that the valuations for a significant part of the market are looking reasonable following the correction. This can be an opportunity for investors to own companies that will benefit from the improving micro environment at lower valuations than before.
Which camp are we in — macro or micro?
At PineBridge, our investment strategy focuses on bottom-up stock picking.
In an emerging market like India where there are many risks, a deep understanding of the businesses at microscopic level helps immensely. The strength of the business model, the people running the business, and the valuation to be paid are the three most important criteria we evaluate.
This does not mean, however, that we ignore the macro trends, as we are quite aware of important economic developments.
Our portfolio comprises companies we believe are fairly valued and likely to benefit from the recovery in domestic investment. All our companies in this space are net cash, so they should be insulated from the rising local interest rates.
In terms of sectors, we are overweight exporters (such as IT and pharmaceutical companies) that are benefitting from global demand and a depreciating local currency. We have reduced our exposure to defensive sectors, such as consumer, because we view their valuations as expensive and these companies may not be able to capture the upside in the economy.
We select companies carefully in this shifting landscape to enable investors to capture opportunities. This time-tested approach, honed across multiple market cycles, serves as a built-in risk management system to mitigate the risk of permanent loss of capital for our investors.
Learn more about PineBridge’s India equity strategy at pinebridge.com.*
*In Hong Kong, the website www.pinebridge.com has not been reviewed by the Securities and Futures Commission (“SFC”) and may contain information of funds not authorised by the SFC. In Singapore, the website www.pinebridge.com (including any contents therein) have not been reviewed or endorsed by the MAS.
Exercise prudence when investing
Potential investors should consider the following key risks before investing in any of the Strategies mentioned:
Market Volatility Risk: All types of investments and all markets are subject to market volatility based on prevailing economic conditions. Price trends are determined mainly by financial market trends and by the economic development of the issuers, who are themselves affected by the overall situation of the global economy and by the economic and political conditions prevailing in each country. As securities may fluctuate in price, the value of your investment may go up and down.
Investment Loss Risk: Investments may decline in value and investors should be prepared to sustain a total loss of their investment.
FDI Risk: The prices of FDI can be highly volatile. In addition, the use of FDI also involves certain special risks depending on the type of FDI, including but not limited to correlation risk, counterparty credit risk, legal risk, settlement risk, margin risk, as well as other possible risks that may arise.
Equity Risk: The value of shares and securities related to shares may fall due to issuer related issues, financial market dynamics and world events including economic and political changes.
Country Concentration Risk: A concentrated investment strategy in equity and equity-related securities of companies related to the economic development and growth of India may be subject to a greater degree of volatility and risk than a portfolio which is diversified across different geographic regions.
Emerging Market Risk: Emerging markets are typically smaller, less transparent and subject to evolving, less stable political and regulatory regimes.
All investments are subject to regional, industry, market, political, regulatory, competitive, business, financial, and other risks. The risk factors described should not be considered an exhaustive list of risks, which potential investors should consider before investing in the strategy. All investment decisions should be made based on an independent evaluation in consultation with financial and legal advisors.
The source of the information in this document is from Asia Equities team of PineBridge Investments Asia Limited unless otherwise specified.
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In the case of a higher volatility portfolio, the loss on realization or cancellation may be very high (including total loss of investment), as the value of such an investment may fall suddenly and substantially. In making an investment decision, prospective investors must rely on their own examination of the merits and risks involved.
Performance Notes: Past performance is not indicative of future results. There can be no assurance that any investment objective will be met. PineBridge Investments often uses benchmarks for the purpose of comparison of results. Benchmarks are used for illustrative purposes only, and any such references should not be understood to mean there would necessarily be a correlation between investment returns of any investment and any benchmark. Any referenced benchmark does not reflect fees and expenses associated with the active management of an investment. PineBridge Investments may, from time to time, show the efficacy of its strategies or communicate general industry views via modeling. Such methods are intended to show only an expected range of possible investment outcomes, and should not be viewed as a guide to future performance. There is no assurance that any returns can be achieved, that the strategy will be successful or profitable for any investor, or that any industry views will come to pass.
Actual investors may experience different results.
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