China is a good cyclical market to play; India still most expensive relative to other EMs

China is a good cyclical market to play; India still most expensive market relative to other EMs

Arjun Divecha, Partner and Head of Emerging Markets at Boston-based investment firm GMO, is in the middle of roadshows across North America for his newly launched fund, 'Beyond China'. The fund aims to invest in countries benefiting from the “China plus one” supply chain diversification strategy. Given that India stands to gain from this long-term trend, the fund will include Indian investments—despite Divecha currently holding zero weight in India across his emerging market portfolios, primarily due to high valuations.  In a free-wheeling conversation, Divecha talks about his new fund, his take on India Vs China, foreign selling and Trump policies.

Edited excerpts:

What is the idea behind GMO's latest launch, the 'Beyond China' ETF?

It's an active ETF which trades on the New York Stock Exchange. The basic thesis is that people, countries and companies are moving supply chains out of China. One, because of trade tensions with the U.S. and other countries. Two, because of the tensions in the Taiwan Strait. Three, because labour costs have become really high in China. And four, during Covid, people (companies) realised that they didn’t want to be dependent on one supplier.

This is a highly asymmetrical trade. For example, India's electrical and electronic exports which last year was about USD 20 billion. Even if India gets 10 percent of China's exports were at USD 1.2 trillion in electronics, India will get USD 120 billion in trade. That’s a 600 percent growth just by taking 10 percent of China’s trade. So, China does not have to lose very much for other countries such as India or Vietnam to benefit massively. And this (kind of growth) can go on for years.

Already, Apple is moving 25 percent of the iPhone production from China to India. Similarly, Walmart, which five years ago got 80 percent of all of its imports from China, is now down to sourcing 60 percent from the country and is committed to reducing further.

Why was this fund not launched earlier? The 'China plus one' strategy has been in the works since pre-Covid?

This is a secular trend which will go on for years and the impact is visible now. Also, this is an active ETF, we are actively investing in who is benefiting.

Trump's actions so far do not seem to be as disruptive as one would have thought. Do you see more bad news for China translating into more good news for the rest of the world, including India?

He has not focused much on China. With Mexico and Canada, he is still negotiating. But he is not going to do that with China – he is ratcheting up instead.

How do you see the 'Beyond China' strategy evolving?

Our 'Beyond China' strategy is not an anti-China strategy. You can make money cyclically by buying China when it is attractive, which we believe it is right now. In our main emerging markets strategies, we are not really underweight on China anymore. We have been for many years, but at this point, things have turned.

I've been saying for the last few years that one of the problems with Xi Jinping is that when he was growing up, nobody ever told him the story of the golden goose. He didn't seem to realise that it was the private sector that was actually leading the growth of China and everything that was good. Taking on Jack Ma and taking on the private sector has not been a particularly rewarding strategy for him. But it does appear, as seen in the last week, that he's reviewing this. He publicly met with Jack Ma and some other corporate leaders.

There are three factors behind it:  a) cheap market; b) government policy being accommodative of capitalism; and c) an economy that has been ready to recover for a long time, post Covid. There's a fair amount of pent-up demand also. They've got problems because housing sector has been in the doldrums, yet you may now have the catalyst for a fairly good rally in China.

So, while Beyond China is a good long-term secular trend, China today is definitely a good cyclical market to play today.

While you are certainly neutral, or overweight on China, what’s your position on India?

We're about equal weight in China. We are very underweight India (close to zero) because of the valuation. Our main fund is a deep value fund, meaning that it focuses on valuation more than anything else. We also have Taiwan, Korea, and with Brazil, we were underweight but are now moving to overweight. We have fairly diversified across the rest of the emerging market space: Turkey, Poland, places like that. There are no sharp big bets, nothing which really stands out as a country that is extraordinarily cheap or attractive at this point.

You are zero weight in India. Does the recent correction get you at least interested? Rather, at what level of correction will India start to look attractive for you?

It’s not 0-1 – we evaluate things continuously. There are three factors which matter overall: valuation, macroeconomics, momentum. And it’s a relative game. India is still the most expensive emerging market on a relative basis. We do give credit to India for having good macroeconomics relative to a bunch of other emerging markets, so you could say that when Turkey is trading at 10x earnings, it may not be cheap, but India trading at 18x earnings, it may be cheap, because you're adjusting for the underlying macros. Still, right now, on relative basis India is still very expensive.

We have also accelerated foreign selling for the last four or five months. In fact, since September, we've lost about USD 26 billion in FII money. How do you explain this?

I do not really have a good sense of this. But valuations always matter. About five months ago, I was rather surprised to see foreigners holding so much money in India, because the market was really expensive. And so, I could imagine the sell-off. But let's be clear, if you do a correlation of flows versus the previous 3-6-12 month returns, you'll find a fairly strong positive correlation. Flows always tend to follow returns.

Looking at markets tactically, it is easy to make a case for investing in China as it seems attractively priced. This could possibly mean a lot of money moves back to China? Now, will that mean a loss for India?

I don't think so. India has definitely benefited from the investors leaving China. Now, a fair amount of the money that has left China is not going back. And that's because of political, and other reasons. There's certainly other money, which is valuation driven, which will go back to China. As the momentum is starting to turn, as observed in the last few weeks, we will see that money going back to China. But I don't think that 100% of the money that left China in the last four or five years is going to go back. And the wildcard, quite frankly, is Trump tariffs. We've never seen this kind of dramatic policy stuff going on. We don't know yet how serious it is, or how formative it is.

Do you think India is facing any macro risks?

I don't think India is super vulnerable in any particular macro dimension. I think India is in a fairly good place from a longer-term perspective. And quite frankly, the currency fluctuations, everybody makes a big fuss about it, but I'm a big believer that poorer countries should have weak currencies. Weak currency is a good thing for the country; it lets you export and forces you to be more efficient in terms of local production.

Doesn't that spoil the equation for foreign investors who are coming purely for financial gains?

India is not run for the benefit of foreign investors! India is run for the benefit of the citizens who live over there. I mean, you should not run your policy trying to please foreign investors. You want to do the right things and that's what attracts the money. You can't put the cart before the horse.