Aberdeen keeps overweight stance on India but cautious over these 2 hurdles

Funds are likely to turn towards emerging markets and one big market that international investors will look to India particularly because of strong fundamentals especially after demonetisation, said Young.

The government in a surprise move in November 2016 banned high-value currency notes of Rs 500 and Rs 1,000 which hit the India growth story to a certain extent, but it was not something which could shake our confidence, explains Young.

“India's economic course is generally set fair and we could be looking at the economic growth of about 6-8 percent going ahead,” said Young. The animal spirits within the Indian economy have pretty much been unleashed which makes consumption story more attractive.

He further added that we at Aberdeen never lost faith in emerging markets because this is one place to invest for the long-term. But, they do go through some sticky periods and cycles both in an economic sense and in the sentimental sense.

Economically, things have not been terrible for emerging markets for the last 3-4 years and it is now inevitable that flows will soon find their way back into such markets.

Young further clarified that the money is not coming from the door (from investors) it is coming more from ETF which is moving quickly back into markets.

The Aberdeen India Opportunities Fund’s investment objective is long-term capital appreciation, which it seeks to achieve by investing primarily in the equity securities of Indian companies.

Top ten holdings as of February 2017 include companies like HDFC, TCS, Infosys, UltraTech Cements, ITC, Kotak Mahindra Bank, Godrej Consumer Products, Ambuja Cements, Piramal Enterprises, and HUL.

Below is the verbatim transcript of interview.

Q: It has been scorching start of the year, 20 percent up in most markets and a bit unexpected, the pace at which the rally has progressed. Are you surprised?

A: One is constantly surprised by markets. So, yes, it was a surprise and of course, for people like us it was a bit too much, too quickly, really. We never like prices to run away from us. We are the rather peculiar types of investors who like prices falling and that then, gives us the opportunity to buy good things at cheaper and cheaper prices. But yes, it has been an astonishing rally start to the year.

Maybe putting it in context and looking back more broadly at emerging markets as a whole, they have been out of favour for a very long time and suddenly you see people talking again. The inevitable cycles that we have in sentiment about emerging markets being a little more attractive now and of course, India is one of those big markets that international investors will look to. And of course, there have been strong domestic reasons for India doing well after the demonetisation scare, scare is maybe too strong a work to use, but a hiccup is a better word.

Q: Do you really think the tide is turning because the last four odd years have been difficult for emerging market investors. People were at a point, beginning to doubt the whole story. Do you think people are just chasing prices right now because of the momentum or the kind of interest you are seeing is probably heralding some kind of a mid-time term?

A: I think it is hard to make that call. There is an element of momentum certainly - oh my goodness markets have turned a bit, they are running, we better get on the bandwagon - and people jumped immediately in things like exchange traded funds (ETFs) for example. For investors like us, we never lost faith in emerging markets and clearly emerging markets are the long-term place to invest but they do go through some really sticky periods and cycles both in an economic sense and in a sentiment sense.

And I would argue economically things have not been terrible for emerging markets generically for the last three-four years. Yes, they have been tough from commodity related markets but for the likes of India, economically it has been a good period. What we have seen over that period however, has been far more to do with sentiment, all the big pictures, elements going on, what is going on in the US, quantitative easing (QE) and we had Ben Bernanke marking the top of emerging markets for 3-4 years ago now, saw emerging markets peak, money coming out of emerging markets. So it is inevitable money will go back into emerging markets.

Q: But through what kind of vehicles because sometimes that tells you more about whether it is chasing momentum or longer term. This time around is it ETF kind of momentum money or are you guys getting money as well?

A: We are not getting much money in the door; it seems to be more from ETF money moving quickly back into market. We certainly saw probably best part of three years of redemptions and that certainly slowed down substantially. That was the overall switch away from emerging markets, not a call on India; it's more a call on emerging markets generally and that certainly come to a grinding halt the outflow but we haven't seen dramatic inflows back into our funds.

Q: Do you think that would be consistent with other India dedicated funds or country specific funds too?

A: I would suspect so, unless you are running ETFs of course, which tend to be far more reflective of the broad top down calls. As you know we are very bottom up fundamental and we can be very different from indices and at times people just want to buy the index. We think India is going up therefore buy or we think emerging markets are going up therefore we buy Morgan Stanley Capital International (MSCI).

Q: How do you read this global rally? Do you think it is sustainable or do you think an air pocket is coming soon, given how fast we have moved and the kind of valuation we are trading at now?

A: My trouble is that I am getting to such an age where one gets more and more conservative and worried about the world. It is very hard in many ways to be totally optimistic about what is going on in the world with what is happening in the US politics and certainly overall we are not seeing a sharp pick up in global growth. So that makes many years now that the world economy has been not quite stagnant, but very quiet. And that certainly continues whereas asset markets particularly stock markets on the whole particularly the US of course have been remarkably strong, almost diverging from the real world.

Q: Irrationally so, you think?

A: Rationally in so in one sense. It is rational actually in some sense. It is irrational in other senses. So irrational, do you think the stock market follows and reflects how well the economy is doing. Ultimately, maybe yes, although ultimately, I think it is also more reflective of how well the individual constituents of the stock markets are doing. So, that does not necessarily equate it with the economy itself although it can be a reflection of the economy. But over shorter term periods and this will be 5-10 years at times that can be quite short-term in overall cycles, markets can be affected by other things.

So, the rationale of markets moving and being quite firm can in part, maybe a large part, be attributed to QE. The fact that your traditional safe money that you had put in the bank, maybe 5 percent or maybe even 10 percent at certain periods is earnings you absolutely nothing. So you are forced into other instruments, riskier instruments ultimately to get that yield and that certainly put people into stock markets where stocks markets, equity markets are yielding more than the corresponding government bond markets in certain cases.

So there is a rationale behind it, but it is not a comfortable rationale, it is not as though earnings per share (EPS) growth has been growing at 20 percent compound for the last five years. That is a rationale we, as fundamental investors, tend to feel a little more comfortable with. The fact that earnings for the corporates with which we are investing and which constitute the indices are growing sharply and generally EPS growth for the Asian region as a whole over the last three years has been single digit rather than double digit.

Q: What is the biggest risk after such a rally globally? What do you think is the biggest possible roadblock for the market?

A: These are the risks that we can never really predict but the big risk is of course interest rates going up, reversal of QE, money being sucked back out of markets, maybe. In some sense it is broadly expected to happen so one wonders whether it is a real risk or a risk that has been discounted. These are the million dollar questions.

Maybe risks that we worry about more, certainly from our point of view, tend to be the more basic individual risks of businesses and so on, but that is probably more stock specific than broad market specific. And of course we have got politics and politics has been confounding everyone over the last few years – trade wars, there are so many risks that you can throw out there and in some senses, the world looks more worrying today than it did 10 years ago. But, maybe 10 years ago, we were worried about different things of course.

Q: What about India, we have also had a good rally, what you said about Asia, holds true about India as well? Last 3 years we have not seen any meaningful earnings growth, do you think it is around the corner or can you predict that with certainty, do you think it might continue to falter to deceive?

A: I am not sure one can predict things with great certainty these days. I am not sure one ever could predict things with certainty. What does seem clear is that India’s economic course is generally set fair with a fair-wind and good government which is never a given, I am afraid, in India. We could be looking at economic growth 6 percent maybe as high as 8 percent with a fair-wind. So certainly the animal spirits within the economy are pretty much unleashed. We still have a lot of reforms to come through.

You have then got to see that whether that translates to EPS which ultimately will drive the market but I think there is a lot to go for in India and we have been overweight India for 20 or more years in our portfolios. We still are to this stage. We find, in India, slightly the broad picture a very long-term growth and we are very long-term people. We have sat with many of our investments for 10-20 years and we have had some bad years within that period, of course, but we are looking beyond it, the far longer term and it is with some assurance one could look at India and say this is the place to be.

Q: But as long-term investors you would be bullish on Indian consumption as a story.

A: Yes.

Q: Did you tweak any of your consumption related holdings because of what happened with demonetisation? I did see that you probably took out a two-wheeler stock or maybe prune holdings in some consumer stocks, do you think it has affected the near-term trajectory?

A: Yes, we tweak all the time largely in reflection of our own flows. So rather than us saying we now like or dislike India or a particular stock is often a reflection of a client has given us money or client has taken money away from us. So on demonetisation itself, that did not cause us to say oh, we must get out of Hero for example or anything like that. It certainly wasn’t a true reflection of demonetisation because we see that as a very short-term blip and it is certainly was a, in some cases, a very major blip.

Q: Like two-wheelers, it still continues to lag.

A: Yes, you are looking at maybe couple of quarters for its effect but we are not managing the portfolio for a couple of quarters. So that hasn’t affected our broad stance at all, we are still optimistic broadly over consumption. Of course, in two-wheelers there could be all sorts of other concerns, competition, etc. But, demonetisation did not cause us to lose faith within India. It was a bit of a shock to us all of course, because you could argue it was either very well handled because nobody knew about it or it was clumsily handled, maybe a bit of both.

Q: What about categories like paints and all which seem to be going through some air pocket because of that? Do you think we have come out of that? You own some paint stocks in India too.

A: Yes, we have held paint stocks. 20 years, Asian Paints and the likes have been fantastic. Yes, it certainly has been affecting business, but again, short-term, if anything, I would say we are more concerned about the valuations of some of these stocks and that certainly applies to the market as a whole, we have probably been saying for quite a few years now, we like India, we think the companies in India are as good as you will find, in certain cases, anywhere in the world. We just wish it were cheaper and that remains, even more so the case today, after India has run ahead.

Q: I want to ask you about the Tata Group because you were quite vocal when that controversy was erupting. Do you think we have put that behind us because some large investors are still concerned about possible eruptions going forward?

A: It is a reminder, in some sense, that even the companies who put on a pedestal which we were all guilty of, have frailties and that has certainly been shown to be the case with Tata. So, it is something we have watched closely. Our only investment was in Tata Consultancy Services (TCS) which has been the jewel in the crown of Tata. Of course, management changes might cause us to watch carefully and we are obviously, watching carefully.

Q: Are you worried about the fact that Natarajan Chandrasekaran, the erstwhile Managing Director has moved to another role in the group?

A: in some senses yes although I think there is far more to TCS than Chandra. He has done a fabulous job, he is obviously well trusted by the family and put into the top-job. So, I do not think that, in itself, is not a massive concern. But it has certainly raised our eyebrows, but we did not see any indication of anything strange going on at TCS itself which is where we have got all our Tata investment is in that one stock.

Q: It is a big holding for you and there are lots of concerns about whether Indian IT is losing its way, slowing down. Are you concerned because you continue to hold that position in TCS?

A: Yes, we would share that concern and certainly, the glory days of India IT outsourcing growth are over.

Q: Over?

A: Glory days are over. It does not mean to say the future is dead, but the dramatic growth which we have seen over the last 25 years from nothing to the phenomenal success stories that TCS, Infosys, have become. I think we are not going to see history repeat itself there, so growth is definitely slowing. The businesses are having to, as businesses do all the time, have to refine their business plans, change track a little. So, we expect and have seen the companies de-rate, but it is hard to find anything of that quality elsewhere within India. So, we are not seeing the Alibaba, Tencent, Baidu phenomenon in India. It has been a different phenomenon.

Q: Have you trimmed your holdings overall as a sectoral exposure?

A: Marginally, yes we have because we have got our main exposure in TCS and Infosys. We have got a smattering of stocks such has Mphasis as well behind that.

Q: What about pharmaceuticals? That is another space which has derated considerably. What are your thoughts on what is going in the US with regard to India pharmaceuticals?

A: In some senses, it is very different business to the IT services, but similar phenomenon happening and in both cases, industries that have done fantastically well.

Q: You do own Sun Pharmaceuticals, still?

A: Yes, we are in Sun Pharma, we are in Lupin, we are in some of the domestic.

Q: But Sun has had a rough ride.

A: Yes, Sun has had a rough ride after an excellent ride. We do not have massive holdings in the pharmaceuticals, but we have decent exposure. Again, that is what India is very good at, as a sector, India really excels at. The issue of course, has been again, the fact that prices were high so valuations were high and people were expecting a lot. And this is always our fear, broadly in markets, not just in India, when we go into a highly rated stock or hold a highly rated stock. If there is any glitch in those earnings and sentiment, you can lose an awful lot of money very quickly and that certainly happened in some of the pharmas.

Q: What about telecom? It has been a long bear market and suddenly there has been a lot of excitement with Idea versus Vodafone. Has it forced you to look at that sector again from a valuation point of view?

A: We have had a long-term small holding in Bharti which has been a very bumpy ride for us and it is certainly a sector we look at closely. So, again, through the Birla Group, there will be some interest for us as well. So yes, we do look at it closely. But there have been such dramatic price falls, there has been a bit of a blood bath for many. But again, it is something that should be part of our portfolio and we had Bharti as part of our portfolio and still do.

Q: The tricky one has been industrials in India because we have just not seen the Capex cycle firing for so long. I do not know whether you own L&T and those kinds of names, but what is your approach to playing industrials in India?

A: We have had big exposure broadly in India more from the cement sector than industrials. So, that has been our big sector play broadly in India and then select manufacturing companies such as Bosch and the likes that again, great company, but hugely expensive.

Q: But you do own different kind of cement companies. I think you own Ramco and some of the smaller companies too.

A: Yes, we have Ramco in our traditional holding. Our first cement holding that we still hold to this day was Grasim Industries. So, Grasim, UltraTech Cement, ACC, Ambuja Cements. It is a sector we like as maybe a safer play on overall development and the building out of India although of course, the cement price can fluctuate sharply and it takes one extra bag of cement in production to cause the cement price to fall sharply. So it can be a volatile sector.