Britain’s chancellor George Osborne was in India this week, praising the new government of Narendra Modi for its “ambition, drive and pace” and noting the turnround in sentiment towards the country since Mr Modi’s historic election win in May.
Mr Osborne did not say it, but the renewed optimism surrounding India has coincided with a marked weakening in investor sentiment towards Asia’s other superpower: China.
When it comes to economic development, China has trounced India. Back in 1980, when the “middle kingdom” was emerging from the chaos of the Cultural Revolution, Indira Gandhi’s India was the richer country.
By the early 1990s China had overtaken India – and by the mid-2000s it was streaking ahead.
“China had a very stable political framework within which to initiate structural reform,” says Rukhshad Shroff, lead manager of JPMorgan’s Indian investment trust. “India has had 30 years of coalition governments. China is 10-15 years ahead as a result.”
But now China is being forced to look beyond the “catch-up” phase of its growth, while investors have huge expectations of the reformist Mr Modi to “uncage the tiger,” as one of his predecessors once put it.
Yet Indian shares are notably more expensive than Chinese ones – so which country makes the better investment prospect?
Sky-high expectations for Modi
India’s new government has taken over at a time when growth in Asia’s third-largest economy has slowed to below 5 per cent, food inflation is soaring and industrial production has contracted, down 0.1 per cent in the financial year ended this March.
It’s also an economy with huge structural challenges. From the water pistols that line the markets around holi, the festival of colours, to the simple coloured strings that sisters present to their brothers on the Hindu festival of raksha bandhan, India has grown reliant on imports for even the simplest goods as stringent land and labour laws have stifled industry.
“When a politician comes out and says I am going to make economic development a revolution like the freedom revolution, to an investor this is exactly the kind of thing we want to hear,” says Abhay Laijawala, head of India research at Deutsche Asset Management.
Mr Modi and his Bharatiya Janata Party (BJP) were elected on a pledge to foster labour-intensive manufacturing, cut red tape, review labour laws and accelerate work on highways and industrial corridors.
“Relative to China the biggest delta I can see is that India is shifting focus from a bias towards consumption to a bias towards investments and infrastructure, whereas China has been trying to move the needle from investment to consumption,” Mr Laijawala adds.
“It’s going to be a very interesting thing to see which country is more successful in terms of this transition.”
Hopes are very high partly because for the first time in more than 30 years, a single party has a clear majority in parliament, giving Mr Modi the power to introduce hard-hitting policy reforms. He has past form: as chief minister of Gujarat, he drew vast investment into the western state with a combination of business-friendly policies, rapid decision making and improvements to infrastructure.
Taking advantage of that optimism in his maiden budget this week, finance minister, Arun Jaitley, set a Rs634bn target for disinvestment to help the government’s planned fiscal consolidation – more than twice the 2014 level.
The equity market could be a big beneficiary of the reforms – not least because the recent rally provides an opportunity for companies, not least India’s public sector banks, to recapitalise.
“[Investors] get frustrated about India because of policy – the companies are very good, managements are very good, they know how to run the company very well but external injection of volatility comes in by way of policy,” says Anup Bagchi, chief executive of ICICI Securities. “If that gets sorted out, then this is the place to go.”
One thing China and India share is a vast and powerful diaspora.
Non-resident Indians, known as NRIs, send large amounts of money to friends and family back home, making India the world’s largest recipient country with total global remittances of $70bn in 2013, according to World Bank estimates. China is not far behind with $60bn.
In past crises, so-called “NRI bonds” have proved successful and when a currency crisis swept through emerging markets in the middle of last year, India’s central bank opened a temporary scheme that drew some $34bn into the country, mostly from NRIs.
China also benefits from heavy investment from companies and philanthropy from wealthy individuals based in Hong Kong, Singapore, Malaysia and Taiwan.
Risky years ahead for China
Despite its miraculous economic growth over the past 30 years, China has consistently stymied portfolio investors. The country’s development has lifted hundreds of millions of Chinese out of poverty and given rise to a new class of super-rich, but macroeconomic success has not translated easily into profits for armchair punters.
Now, with even the macro economy sputtering, portfolio investment in China has become still more challenging. Even if China meets its official 7.5 per cent growth target for 2014, it will be the slowest pace of economic expansion since 1990.
“We’re still advising investors to take a cautious view,” says David Cui, China equity strategist at Bank of America Merrill Lynch in Hong Kong.
“China’s business environment will deliver challenges for a few more years as the corporate sector struggles to deleverage, potentially in the face of lukewarm demand growth.”
But investors looking to buy and hold can invest in some big trends that will transform China’s economy in the coming years – even though such returns may take some time to materialise.
In a landmark economic reform blueprint that Communist Party leaders approved late last year, top leaders pledged to transform the country’s growth model away from excess reliance on debt-fuelled investment and exports, and instead promote the development of domestic consumption and services.
Analysts expect sectors such as healthcare, green energy, retail, and non-bank financials to benefit from this reform agenda. Some traditional industries like utilities and oil and gas may also benefit from deregulation of energy prices.
But traditional heavyweights such as banks, property developers, machinery makers, and construction material manufacturers may suffer. Outside the country, raw material exporters particularly in Australia and Brazil may also find life tougher.
Though most Asia-based analysts expect the reforms will take several years to show up in corporate profits, some observers are also optimistic about the short term, given current low valuations.
“We expect an accommodative monetary policy to help revitalise private investment and build growth momentum. We believe valuations look attractive and the market offers reasonably high yields,” Herald van der Linde, head of Asia Pacific equity strategy at HSBC, wrote in a note to clients this week.
What investors agree on is that the ability of Chinese companies to deliver consistent returns to investors depends on the leadership’s determination to push ahead with difficult reforms; it has backtracked in the past, such as loosening credit in early 2013 to juice short-term growth, even at the cost of adding to long-term debt risks.
In recent weeks, several local governments have announced plans partially to privatise state-owned firms. Policy makers hope that a larger role for private investors will increase efficiency and improve corporate governance.
Recent regulatory changes aimed at depoliticising the approval process for initial public offerings, cracking down on fraud by accountants and underwriters, and forcing weak firms to delist should also improve the quality of Chinese equities.
Those predicting doom for the Chinese economy have been consistently proven wrong over the past decade. But maintaining economic growth – which the Party relies upon for its legitimacy – is becoming increasingly difficult as China approaches nears the end of the “catch-up” phase of its development.
“The economy may undergo profound, and often unpredictable, changes, so picking winners requires a genuine understanding of China’s economic and political system, and of course, patience and nerve,” says Mr Cui.
Putting money into India is effectively a bet on broad economic and political reform, says Matthew Beesley, head of global equities at Henderson. On the basis that a rising tide floats all boats, an index-tracking investment is probably as good as any, he adds.
Investing in Indian companies is impossible for individual investors and not straightforward for institutions; many non-specialist funds buy participatory notes or depository receipts rather than shares. Depository receipt programmes are only run by the biggest companies, while “ p-notes” do not carry voting rights. “That’s a problem in a country where corporate governance is a massive issue,” says Mr Beesley.
However, India does have a solid legal system and great corporate diversity. “Sectors like IT services are big in India but completely absent in many other emerging markets,” says Mr Shroff, adding that by a quirk of history, many western conglomerates such as Unilever and GlaxoSmithKline have quoted Indian subsidiaries, although their shares tend to be highly rated.
Like many other things in China, the shares available to western investors – primarily the ones traded in Hong Kong – is determined by the government. Trading shares via the former colony is easy and cheap, but virtually all the “red chips” and “H shares” listed there are ultimately controlled by state or local government.
“The problem with many state owned enterprises is that they may not be run with the aim of maximising returns for minority shareholders. It’s hard to believe they are always making rational investment and capital allocation decisions,” says Mr Beesley.
Buying non-state companies in China is also tricky. “A lot of them are domiciled in tax havens like the Cayman Islands, and their managers often control assets outside the listed vehicle,” he adds.
The valuation argument for China is compelling, concedes Mr Shroff. But he prefers not to view the decision as either/or. “There are reasons to invest in China and they don’t have to the same reasons for investing in India,” he says. “I always say to clients: why not both?”
Options for the direct approach
Most advisers tend to recommend buying generalised emerging market funds rather than country-specific ones, so as to reduce volatility and spread risk. But there are options for those wanting direct exposure.
Lyxor and Amundi both offer exchange traded funds (ETFs) tracking the MSCI India index, while Deutsche Bank has one that tracks the “nifty fifty” index. All employ synthetic replication rather than owning the underlying shares directly.
There is more choice for China. Most ETFs tend to track either the MSCI China or the FTSE Xinhua 25 indices, both of which comprise large state-controlled Chinese companies whose shares trade in Hong Kong. Examples include HSBC MSCI China and iShares China Large-Cap.
However, Adam Laird, head of passives at Hargreaves Lansdown, points out that some ETFs are now investing directly in A-shares. “These tend to be more attuned to the Chinese economy, though they have been more volatile,” he says. He thinks the best is ETF Securities’ MSCI China A GO UCITS ETF; it has ongoing charges of 0.88 per cent and holds the top 20 companies. Deutsche Bank and Source Markets have similar ETFs with a more broad coverage, though their charges are higher.
Jason Hollands at Bestinvest says most actively managed Indian funds have annualised volatility of 20 per cent or more, and so are very high risk, and for this reason he prefers broader funds such as Lazard Emerging Markets. “For those willing to risk investing in a single country fund, we like Aberdeen Global Indian Equities – but with just 30 stocks, it is not for the faint-hearted.”
Brian Dennehy at Fundexpert.co.uk, who is bullish on India, recommends the Jupiter India fund. “My experience in higher risk sectors with momentum is also just to get on board – by the time you’ve finessed a cheap way to access the market, shaving a decimal of a per cent here and there, you’ve lost 10-20 per cent of performance,” he says.
The longest-established Indian investment trust is JPMorgan India, which has £500m of net assets. Despite a 25 per cent price gain so far this year, it still trades at a 15 per cent discount to NAV. Alternatives include Aberdeen New India and India Capital Growth, whose small-cap focus has resulted in a 36 per cent price gain over the past year.
Most actively managed China funds – First State Greater China, Invesco Perpetual Hong Kong and China and Threadneedle China Opportunities are among the top-rated by Morningstar analysts – tend to own shares in large Chinese corporations traded in Hong Kong or New York, or Taiwanese companies with heavy exposure to mainland China.
One fund with a tilt towards non-state companies is Fidelity China Special Situations, run these days by Dale Nicholls, rather than founder manager Anthony Bolton. It has a policy of focusing on smaller, more entrepreneurial, consumer-facing companies, a high-risk approach that led to a period of well-documented underperformance in its early days. But over the past year the fund has outperformed the MSCI China index in both price and NAV terms. “Small-caps have greater agility to adjust to a changing environment, particularly if domestic demand is growing,” says Mr Dennehy.
This article has been republished to correct the spelling of ‘Gandhi’.
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