The best way to take advantage of the long-term growth story in India is through the small and mid-cap sector.
This is according to David Cornell, manager of the India Capital Growth Fund (ICGF). In an exclusive interview with Capital.com, Cornell explains that in the same way that the FTSE 100’s constituents make most of their sales abroad, the same applies to India’s large caps in the BSE Sensex 30.
“If you invest in a large-cap Indian fund – the portfolio will be concentrated on the top 50 stocks in the market and when you break down the revenue streams of these companies they will be predominantly from overseas. Is that really investing in the India story?” he says.
Cornell argues that small and mid-caps are the engine room of India and allow investors access to companies that are ideally placed to benefit from the structural growth potential of the domestic economy.
While there are more than 5,000 listed companies in India, Cornell explains that, after using a qualitative and quantitative process, around 4,000 of these names will be knocked out straight away. The remaining 1,000 companies will be then whittled down to 150 (taking out large caps and those seen as illiquid). From this remaining 150, Cornell and his team of analysts in India will then pick out the best 30 to 35 ideas, resulting a relatively focused portfolio.
With so many companies in India – from the large right down to the smallest cap, family-owned firm – it does make stock selection challenging. However, Cornell believes that access to and governance of these companies is improving.
“A lot of Indian students study abroad and when they come back from Europe, they often have new ideas about shareholder value and good corporate governance. And if you identify these companies that are more transparent in how they operate – and get in early – you can do really well,” he says.
There is no shortage of growth opportunities in India, according to Cornell, as demand in so many sectors is being driven by high consumer demand. Consumer spending (and saving) is growing in India as the standard of living improves – but as Cornell points out this is from a very low base – and is still a long way behind China.
“We see the financial sector as a good play on the consumer story – mortgage growth potential is enormous and we are still at the early stages of demand for savings and insurance products too.”
What is the key driver here? Is it just that incomes are rising and first-time buyers have the resources to purchase their own property?
It is a cultural shift as well, according to Cornell. “Young people in India now want to have their own place. The old ways of grandparents, parents and children all living under the same roof is beginning to change.”
Helpful government reforms
Five years of reforms under Prime Minister Narendra Modi – including regulation relating to real estate, banking and new tax rules – have helped shake up how Indian companies operate and progress.
Cornell reveals that the new rules-based style of regulation has led to a lot of ‘old school’ companies selling out to private equity firms. At the same time, high-growth tech and digital companies are coming through that look to private equity support. This then leads to more market listings.
Given that ICGF has an analyst team on the ground in India, how important is it to kick the tyres of companies included in the portfolio – essentially visiting the firm and meeting the senior management?
It is a vital part of the job, according to Cornell and he concedes that due to the pandemic this has just not been possible recently.
“The turnover of our portfolio is quite low and the companies we have bought in the last 18 months we had in fact already met previously. During the pandemic we may not have been able to physically meet companies, but virtual meetings have helped keep us up to date”.
One addition to the portfolio that Connell namechecks is Sona BLW, which is a play on electric vehicle growth. The company is the sole supplier to Tesla in China – earlier this month, Sona BLW reported revenue up 226% (year-on-year) for the quarter to the end of June.
The automotive technology company, which provides mission critical systems and components for electrified and non-electrified powertrain segments, is exactly the sort of company ICFG looks to invest in at an early stage.
While the growing power of the consumer in India is already evident, the next big story is going to be mainstream digitalisation, according to Cornell.
“There are no Alibabas in the listed space in India today – the stock market in India is very old school. But as more and more tech companies come to market, the picture is going to change.”
He points to the fact that India is seven years behind China in terms of digital adoption but that the growth rate is significant and to a large degree the pandemic has fast-tracked this progression. Online retail sales are growing at 90% a year but this is still years behind the US and China.
“Indian consumers are buying sophisticated insurance products online and using smartphones to make payments. They have skipped the laptop stage and gone straight to the mobile phone.”
For the cavalier investor, who is quite prepared for a white-knuckle ride, India can be a lucrative but potentially perilous place to be.
Yes, infrastructure development is an attractive investment theme, but with an order book dependent on local government contracts it can quite often be a murky space.
Similarly with pharma, generic drug companies are often dealing with complex formulas – there is potential for significant returns, but it is high risk and very much in the boom or bust bracket.
As Cornell explains, he is prepared to pay high multiples for quality businesses rather than companies growing at 30% – where there is no clear indication of how that growth rate can be sustained.
ESG in India
In recent years, Environmental Social and Governance (ESG) investing has received blanket coverage in the media – with the UN’s Sustainable Development Goals and the upcoming COP26 meeting in Glasgow focusing the minds of both government and corporates on action. How far is India in embracing ESG?
“ESG is a part of everyone’s thought process right now but in India the ‘G’ is at the forefront. In India, the ‘E’ and the ‘S’ don’t have the level of oversight you have elsewhere in the world. However, environmental and social factors are beginning to filter through and there is an increasing awareness of what is greenwashing and what is not,” says Cornell.