Thinking India. - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
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27 MARCH 2008

Before you read this article, please reach for your remote.
Switch off the business channel you have on your TV set.
Stay away from the noise and constant chatter - keep the TV channel off for a few days.
That is essential to clear your mind.

While I am not happy with the erosion in value of my investment in the Quantum Long Term Equity Fund, I am not in any sort of panic mode.
And neither should you be in any sort of panic.

Since the start of the year till March 19th, my investment in Quantum Long Term Equity Fund saw a decline of 25.2% (when measured in USD). This is after all the expenses and fees of the Fund. Over the same time period the BSE-30 Index declined by 27.9% and the BSE-200 Index has lost 32.3% (all in USD). Against the MSCI All Country World Index (down 12.2%) and the MSCI Emerging Market Index (down 14.4%), the performance of the Indian stock markets looks quite bad.

Table 1: Caught in a downdraft, YTD and QTD performance
Dec 31, 2007 March 19, 2008 % Change (in USD)
MSCI World 403 354 -12.2%
MSCI Emg Mkt 1,245 1,066 -14.4%
Quantum Long Term
Equity Fund (NAV in INR)
17.26 13.24 -25.2%
BSE – 30 (India) 20,287 14,995 -27.9%
BSE – 200 (India) 2,656 1,843 -32.3%
Indian Rupee / USD 39.41 40.43 -2.6%
USD / EUR 1.4590 1.5625 -7.1%
Source: Bloomberg, Quantum AMC data

But investors should view this recent turmoil as an "external" factor which does not in any way dilute the fundamental reason why investors should invest in mutual funds or in stock markets.
India’s economy will grow by over 6% per annum in real terms for the next decade. This economic activity will give many companies a chance to grow their businesses - hopefully, profitably. Higher profits can result in higher share prices. This may give investors an opportunity to potentially earn sensible risk-adjusted returns of 15% to 20% per annum. That could translate to a 4x to 6x increase in your investment in 10 years.

Like anything we do in life, there are risks of investing in India (politics, bureaucracy, poverty, government deficits). I don’t believe that much has changed over the past few years to increase or decrease these long term risks. They still remain. The governments in power have a lot of work to do on many fronts.

Meanwhile, the world financial markets are in a tizzy.
The Indian stock markets, mesmerized by global cues, have fallen prey to the whimsical movements of the Dow.

The decoupling story, the big driver for the hype surrounding the Brazil, Russia, India, China (BRIC) story, has been beaten into an embarrassing silence. Just like the "new economy" theorists (they said that the birth of the internet would remove the occurrence of business cycles) were humbled by the deflating of the internet bubble.

The US has sneezed, and this time the world was wearing no clothes: there is a severe chill that has spread across all financial markets.
So much for global warming.

There is a danger, though, that the hype on the upswing will be converted to gloom on the downswing.
The headline stories that spread the popular myths need some explaining.

Fact #1: India has not had a disastrous performance.
The decline in the Indian stock market that was outlined in Table 1 above needs to be put in context.

The sub-prime crisis dominated the headlines since August 2007 with the problems of the Bear Stearns fund. By March 19th, 2008 Bear Stearns itself was the victim of this developing crisis.

Over that time period (from July 31, 2007 to March 19, 2008), the Indian stock markets - while in the negative territory - have actually outperformed the S&P 500, the Dow Jones 30, and the MSCI World and MSCI Emerging Market Free indices.

My investments in Quantum Long Term Equity Fund which is focused on the long term had a negative 2.2% return.

Table 2: Caught in a downdraft, YTD and QTD performance
July 31, 2007 March 19, 2008 % Change (in USD)
S&P 5001,455 1,298 -10.7%
Dow 30 13,212 12,100 -8.4%
MSCI World 392 354 -9.9%
MSCI Emg Mkt Index 1,100 1,066 -4.2%
Quantum Long Term
Equity Fund (NAV, in INR)
13.54 13.24 -2.2%
BSE – 30 Index 15,551 14,995 -3.6%
BSE – 200 Index 1,894 1,843 -2.7%
Indian Rupee / USD 40.44 40.43 Flat
USD / EUR 1.3698 1.5625 -14.1%
Oil, WTI (per barrel) 78.21 104.48 +33.6%
Gold (per troy ounce) 664.30 944.20 +42.1%
Source: Bloomberg, Quantum AMC Pvt Ltd

Fact #2: India has performed poorly - from a steroid-induced peak.

Table 3: India falls sharply from a peak
Recent peak on Peak level March 19, 2008 % Change from peak
(in USD)
S&P 500 Oct 9, 2007 1,565 1,298 -17.1%
Dow 30 Oct 9, 2007 14,165 12,100 -14.6%
MSCI World Oct 31, 2007 428 354 -17.3%
MSCI Emg Mkt Oct 29, 2007 1,338 1,066 -20.3%
BSE – 30 (India) Jan 8, 2008 20,873 14,995 -30.2%
BSE – 200 (India) Jan 7, 2008 2,744 1,843 -34.7%
Quantum Long Term
Equity Fund (NAV, in INR)
Jan 4, 2008 17.41 13.24 -24.6%
Indian Rupee / USD Oct 11, 2007 39.25 40.43 -3.0%
USD / EUR March 17, 2008 1.5730 1.5625 -0.7%
Oil, WTI March 13, 2008 110.3 104.5 -5.3%
Gold March 14, 2008 1,002 944 -5.9%

India is, in some sense, a victim of its own success.
Hordes of Indians with a good command over the English language have descended on the traditional pools of money in Hong Kong, Singapore, Dubai, London, Boston, and New York.

When money that is willing to believe meets believable people with believable stories, the heavens set in motion a celestial love song that would make a peacock’s dance look like a dull, ordinary event.

We can only conjecture that, when bobbing heads emerged from sub-prime news that submerged global markets in August, the world shouted "India" as they gasped for absolute returns from a "safe haven".
To our utter astonishment, India received USD 6 billion of foreign money in a 3 week period between September and October 2007. The "normal" run rate is USD 0.8 billion a month. So this was an off-the-charts event.

It was the power of that USD 6 billion - amplified by another USD 15 billion from local punters willing to surf the tide of foreign flows - which propelled the markets to fragile heights.

As the graph below indicates all that happened between July 2007 and March 2008 was that an over-charged India has deflated to be in-line with its peer group.

India back in line.

Source: Bloomberg

Fact #3: India will not be hit by a slowdown in growth in the global or US economy; India has not "re-coupled".
India is not an export-led economy. Ask your cousins and friends who live in USA to look around their homes list all the products that are "Made in India". There will be very few products (maybe 3% by value) that are "Made in India". The new home construction in USA from 2003 to 2007 added little to India’s export pool so the slowdown in real estate will have little impact on most Indian companies.

The fact is that India will be - and has been - affected by foreign capital flows, not by real economic activity. The P-Notes gave unknown investors with unknown time horizons a free ride on the India bandwagon. If those investors need their money to head back home to shore up the home-country balance sheet, the Indian stock markets will stay subdued. A misguided policy on P-Notes has ensured that India is fully coupled to global capital flows and mood swings - but its economy tends to be quite un-correlated to the world.

Table 4: Foreign money determined India’s stock market levels,
but note the jump in local mutual fund flows CY 2008 YTD.
Period Foreign Activity
(US$ m)
Local Mutual
Fund Activity
(US$ m)
Total
(US$ m)
Change in BSE-30
TRI in that period
(%, in USD)
CY 03 6,940 93 7,033 +86.3%
CY 04 8,958 -261 8,697 +23.1%
CY 05 10,896 3,089 13,985 +42.2%
CY 06 7,994 3,442 11,436 +53.3%
CY 07 17,236 3,121 20,357 +68.5%
YTD 2008 -2,801 1,395 -1,406 -14.3%
Cum Total 49,22 10,878 60,101 621.8%

Fact #4: India may stall, till the general elections are held before May 2009.
The news flow on India will focus on the general elections - to be held before May, 2009. Our argument is: it does not matter who wins. The Indian economy will chug along at 6.5% p.a. - as it has the previous 27 years while under the rule of 8 governments, 5 of which were coalition governments. India has witnessed every imaginable global and domestic headwind and tailwind in this period.

If "stall" means that no short-term investors will shovel USD 6 billion into India in 3 weeks - we agree. India is in a "stall".

If "stall" suggests that no foreign investor will buy into India for the next 12 months, well, that may turn out to be correct. Or it may not. Foreign investors may start buying again.

We would argue that the best time to buy something is when no one wants to buy it - particularly if what we are getting is some high quality product, at an inexpensive price. And the investment time horizon is 3 to 5 to 10 years out. There are many Indian companies that are world class and have proven their ability to make respectable profits across various challenging environments.

Fact #5: India is under-owned by foreign and local investors.
India has received shorter-term tactical allocations from the day-trading type of foreign investor via the P-Note route. The long term strategic, allocations from really long term investors have yet to begin.

Buyers, as such, are not in short supply. There is an estimated USD 20 trillion of pension money in the developed world. If 50% of that goes to stock markets that is a total of USD 10 trillion. And if 1% of that equity portion finds its way into India, that amounts to a total demand of USD 100 billion. This is 2x the flows that India attracted over the past 10 years.

The sovereign funds from the Middle East - where India is a natural home and the developed world markets are seen to be more hostile - could account for another USD 10 billion waiting to enter India. And this money has the ability to move faster.

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The Indian pension funds, with another USD 50 billion in assets, have zero equity. The government-appointed committees have recommended a 20% to 40% exposure: that adds up to another USD 10 to 20 billion. Legislation for this has been stalled for a few years so the trigger for this may be more than one year away.

The domestic investors - with 3% of their incremental household savings (total household savings are US$ 300 billion) finding their way into the Indian equity markets - could increase their flows. In the late 1980’s and early 1990’s, Indian households invested 10% of their savings in equity. We have already seen a 40% yoy growth in equity mutual fund inflows YTD.

Conclusion: Plan for the long term investment returns.
While the long term money flows are large, these buyers may not show up tomorrow.
But the exit of short term money may renew again.
There is probably another USD 6 to 10 billion of foreign short term money in India. So there could be the sharp falls like the ones we have witnessed in May, 2004; May, 2006; January, 2008; and February, 2008.

Though we know these statistics of potential short term sales, you should not plan for those sell-off days - because they may never occur.

But, as an investor, focused on your long term growth of your savings, you should continue to buy into a basket of mutual funds that match your risk-return profile.

In the near term the stock markets in India may not attract the positive press coverage that it has enjoyed the past few years.
Maybe a few business TV channels will close down and spare us the constant commentary that one usually associates with gambling at the horse race-track.

But over longer periods of time, an investment in a stock market in a growing economy can still offer magical and real long term returns.
Without taking undue risks.
Without watching the business channels on TV that need to find words to describe every irrelevant movement of a company’s share price.

Suggested allocation in Quantum Mutual Funds
Quantum Long Term Equity Fund Quantum Gold ETF Quantum Liquid Fund
Why you should own it: An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 15% 5%

Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Note: Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Private Limited.

Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments.


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