Why India is standing out from the emerging market pack

01 October 2021

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  • Summary
    • The outlook for India is better than many other emerging markets. The sustained economic recovery is backed by government and central bank support, and healthy pent-up corporate and household savings
    • We have conviction in quality companies and the attractive outlook for domestic corporate earnings suggests that equity valuations have room to expand
    • Although elevated volatility across asset classes looks likely to be the order of the day for some time
    • As the economic recovery gathers pace, bond investors chasing higher yields might consider allocating funds to mid-yield, high-yield and structured credits
  • Full article

    While volatility is likely to be elevated, there’s growing confidence in the strength of the Indian economic recovery, with diversification key in the months ahead.

    Despite nothing being guaranteed when it comes to investing, almost all conditions needed to support a sustained Indian economic recovery seem to be in place.

    • The spread of COVID-19 seems well contained, despite the busy festive season being underway
    • The inoculation rate in India continues to gain pace, in line with our expectations, demonstrating the availability of and acceptance for vaccines
    • The long series of pro-growth reforms introduced by the government over the last few years
    • Both fiscal and monetary support continue to provide sufficient, targeted support where needed, as seen with the government’s performance-linked incentive schemes this year
    • The growing strength of the Reserve Bank of India’s (RBI) forex reserves provides the necessary shield to allow a more accommodative policy stance relative to other emerging economies
    • With the economic growth gaining pace, supply-side bottlenecks seem to be easing (barring some of the global supply issues such as semiconductor chips)
    • The risks to rural growth emanating from the erratic Monsoon season also seem to have abated
    • Robust liquidity and capital, both local and global, are available to businesses ranging from blue chips to start- ups continues to be robust
    • Pent-up savings have supported the robust recovery in demand, for now.

    Tough execution targets

    The pace of the government’s capital expenditure remains constrained by tough execution targets, and has room for a significant pick up in the second half of this fiscal year. However, a period of broader, better-quality growth depends on:

    • The private sector participating more, with capital expenditure plans getting executed
    • Credit growth picking up (the inverse of the deleveraging cycle witnessed across many sectors)
    • Employment picking up, especially the big void created in manufacturing, construction, retail, travel and hospitality.

    Patience needed

    All this will take time, and patience. While policymakers continue to keep a close eye on these economic indicators, equity investors should watch the latest quarterly corporate earnings season underway. We do not see them being disappointed. In fact, the incoming data are likely to support their optimistic outlook.

    Any equity market corrections may be short-lived

    However, Indian equity valuations, as seen in earlier cyclical bull runs, may start pricing in forward earnings for two or three years out. Valuations also have room to stretch considering the attractive earnings growth profiles of Indian companies, reducing debt levels and historically low cash flow discounting rates. With so much money lying on the sidelines, and with cash and debt yields so low, many may buy on any dip. Therefore, any corrections may be short and shallow.

    With so much money lying on the sidelines, and with cash and debt yields so low, many may buy on any dip. Therefore, any corrections are likely to be short and shallow

    Volatility may remain elevated

    With investors focusing on when and how quickly central banks reduce asset purchases, inflation, the Delta variant, China and valuations, market volatility is expected to remain elevated.

    Investors might consider rebalancing opportunities to book some profits in Indian equities back to their neutral allocation levels, and use any dips to stagger fresh allocations. For more discerning investors, buying a portfolio hedge, to extend their portfolio carry of overweight Indian equities, may be a more efficient way of reducing systemic risk, while continuing to benefit from active management alpha.

    Quality matters

    We continue to have more conviction in quality companies and investment themes. With the recent catch-up by mid and small-cap equities, we have moved to an equal preference across market capitalisation. Among richer valuations and active sector rotations, pockets of satellite opportunities exist in technology, metals (despite recent volatility), select banks and non-banks, real estate, late- recovery themes, travel and tourism sectors.

    Unlisted opportunities

    Opportunities in unlisted securities continue to attract flows, especially in late-stage venture capital, private equity and the pre-listing markets. Primary markets are likely to be abuzz for years yet, following the progress made by domestic technology and technology-driven businesses in the coronavirus era.

    Global exposure broadens opportunity set

    Besides the opportunity to invest in non-domestic markets, a more diversified approach can allow investment in opportunities expected to prosper. We see opportunities in US equities through quality companies and active management. That said, room for significant upside, in the near term, may remain muted and volatility high.

    High-grade Indian corporate bonds to the fore

    Keeping core portfolios invested in high-grade corporate bonds of up to 5-year appeals, ideally through a mix of roll-down strategies and actively-managed portfolios in this segment. The steep rates curve appears to offer enough carry to compensate for any residual duration risk in these portfolios, although volatility is expected to remain high.

    High-yield, structured and private credits

    Allocating to mid-yield, high-yield and structured credits at this stage of the broader economic recovery seems to have merits. Among bond segments, the non-AAA one seems preferable at the moment, with a focus on rating- upgrade candidates. Although credit spreads are trading at historically tight levels, with demand far outweighing supply, there is little room for error.

    In public debt, we target sectors likely to profit from government policies and the domestic economic revival. This includes infrastructure and residential real estate-backed debt and select non-banking financial companies that focus on housing finance and micro, small and medium-sized enterprise lenders.

    Also, with the latest set of RBI restrictions on banks and non-banking financial companies and enhanced guidelines on credit mutual funds, more opportunities are available for private debt managers in the mid-market performing credit. With risk appetite in this segment still muted, and traditional participants abstaining, this credit market offers opportunities to build portfolios with an attractive risk premium.

    Prudent selection, diversification and monitoring is key when investing in private markets.

    Among bond segments, the non-AAA one seems preferable at the moment, with a focus on rating-upgrade candidates


Market Perspectives October 2021

Our investment experts highlight our main investment themes, looking at how investors can play their part in tackling climate change, if proposed tax hikes might hit equity valuations, bonds fit for this stage in the credit cycle and whether surging energy prices threaten the economic recovery.

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