04 Nov 2021
As media headlines focus on China’s evolving regulatory environment, we take a step back and focus on the opportunity set across the broader region. Our investment team debate the outlook and discuss the key factors shaping the economic and investment landscape across India and the ASEAN region.
It has been a tough 18 months or so for India - the first, slower wave of Covid-19 was followed by a deeper, more devastating second wave. The country is slowly emerging from this crisis, and we are clearly seeing vaccination rates improve. India recently crossed the milestone of immunising 1 billion people. The economy's is slowly getting back on track. Over the next 5-10 years, we expect a strong focus on growth through fixed investment in manufacturing and infrastructure, which alongside attractive demographics, will support consumption and related areas.
Indian equities have performed strongly both in rupee terms and dollar terms over 10-20 years. Valuations are currently fairly steep, with price to book multiples roughly trading at 30% premium to our long-term averages. But interest rates have also declined sharply - short-term rates have fallen from 6% to 4% in the last two years - and that’s a very important driver of this multiple re-rating. Corporate earnings could be impacted if we do not see the expected economic growth of 6-8%. But the greater risk is of another global taper tantrum. Unless we have a very strong global taper, we believe India can sustain these valuations due to low interest rates, a strong economic recovery and policy support in manufacturing and infrastructure.
India currently stands where China was in 2006 on a GDP per capita basis. These are two very different countries with the key similarities being demographics and a large educated population. China, driven by its political system, has been managing its economy in a very narrow range, while the Indian economy is more cyclical and will tend to have its excesses removed by natural cycles. It’s the same principle for Indian equities where the market gives a higher multiple to certain stocks, based on the premise that this duration of growth is for the next 15-20 years without any kind of artificial management of the economy.
We have seen the Chinese economy moving away from low-end manufacturing to a consumption-oriented one, and we expect to see the Indian economy similarly move away from agriculture and manufacturing to a mix of consumption, higher-end manufacturing, infrastructure and digital.
The India government has a goal to increase manufacturing from 15% of GDP to 25% of GDP. They also have a strong infrastructure pipeline with plans to invest $2 trillion in the next five years. There are special incentives for manufacturing in the area of electronics, chemicals, textiles and automobiles to create global competitiveness, as well as incentives for foreign companies to invest more in India.
Within the consumption sector, higher GDP per capita over the next 10 years will be the driving force to more spending. The upper middle household of India is going to almost triple in next 10 years and the products and services this new middle class will demand will also change. Automobiles and white goods such as air conditioners will see increased demand. We are also going to see a huge rise in home ownership which will impact mortgages.
One area that investors can benefit from this consumption growth story is in the financial space. India has some very strong private banks that can benefit from this trend of Indian consumers getting wealthier, which will result in increased borrowing and consumer leverage.
The Indian banking system is still dominated by public sector banks - the ratio of public to private banks is 65:35. But we do see this ratio flipping in the next 10-15 years, with private banks likely to take up 60-70% of the banking system. With an economy which can grow at a nominal rate of 10-12% and lowly leveraged consumers, this creates a very strong backdrop for private sector banks and financing companies that can get easily compound at 15-20% growth per annum.
Among private banks, we see HDFC Bank, ICICI Bank and Axis Bank as top performers because of their strong management teams and improving underwriting culture.
More broadly, we believe that a number of sub-segments within the Indian financials space offer substantial structural growth opportunities with consumer finance, auto loans, mortgage finance, credit cards and digital payments among the more lucrative areas.
The last 18 months have been a real roller-coaster ride for ASEAN countries. Unfortunately, Covid 19 is not quite in the rear view mirror for the region, but we are starting to see progress being made. The real bottleneck to the overall recovery story is that vaccinations have been slower than expected. The region is expected to reach 70% vaccinations by end 2021- mid 2022, but there are reasons to be optimistic. For instance, just this month Thailand which had talked about reopening to 10 countries, opened up to 76. This is a rapidly shifting picture, but we are moving in the right direction.
The Covid-19 recession in ASEAN is probably most similar to the Asian financial crisis versus the global financial crisis (GFC) or the tech recession in 2001. Essentially what we have seen in this recession is that manufacturing held up really well mainly as external demand remained robust with the huge fiscal stimulus in developed markets translating into strong demand for goods.
Another factor is that the decade before Covid-19 saw manufacturing supply chains gradually shifting to ASEAN. What we have seen during the Covid-19 recession is that while construction and services turned negative, manufacturing held up - which is the opposite to what happened during the GFC and tech bubble. This momentum towards manufacturing supply chains shifting to ASEAN has largely remained intact.
Another long-term trend in terms of foreign direct investment (FDI) remains strong. In the run-up to the Asian financial crisis of 1997-98, ASEAN commanded 8% of the share of world FDI. But the decade that followed was definitely a lost decade as the region ceded leadership to China. Since 2010, FDI into ASEAN has increased and has picked up further following the US-China trade war in 2008. Despite border closures, this trend has remained with firms making use of technology to complete necessary due diligence.
Similar to most markets, a trend that has picked up pace during Covid-19 is the shift to online. This has also driven a spate of ‘new’ economy IPOs and spells a small but significant shift in market structure, away from traditional heavy industries and banks.
In terms of opportunities, we favour businesses that are strong franchises with sustainable competitive advantages, offer a good runway of future growth, attractive valuations and superior management ability.
SEA Ltd is a beneficiary of the shift to online lifestyles. Structural trends such as an expansion in the mobile gaming segment as well as rising e-commerce and fintech penetration in the South East Asia region are also supportive.
We also see opportunities in mispriced names such Malaysia-based CIMB Group Holdings which offers attractive profitability turnaround potential following an internal management restructuring. TISCO Financial Group has a resilient balance sheet and strong underwriting discipline. The company is a play on the potential recovery in automobile demand from depressed levels.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than other more developed markets. The use of financial derivative instruments may result in increased gains or losses within the funds. A focus on securities of companies which maintain strong environmental, social and governance (“ESG”) credentials may result in a return that at times compares unfavourably to similar products without such focus. No representation nor warranty is made with respect to the fairness, accuracy or completeness of such credentials. The status of a security’s ESG credentials can change over time. Investments in smaller companies can carry a higher risk because their share prices may be more volatile than those of larger companies. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for illustration purposes only.