Twin deficits leave it vulnerable to global risk appetite and there remain multiple challenges – from high levels of pollution in Indian cities, to bottlenecks in infrastructure projects, to the looming general election.
Nevertheless, says Agarwal, it is still a more domestic economy when compared to some other emerging markets and the fund invests in businesses likely to benefit from domestic growth. Modi’s reforms are making a real difference, he believes, particularly the GST (Goods and Services Tax).
“This will be a game changer in the long term. As an example, Unilever in India told us that they halved the number of their warehouses from 40 to 20 in the 12 months after the implementation of GST, with the trucking time of goods reduced significantly as trucks no longer needed to queue for miles at the interstate checkpoints.”
He adds that the arrival of the Real Estate (Regulation and Development) Act in 2016 is another long-term positive as for the first time, homebuyers’ rights are being properly protected.
Governance of Indian companies is also improving: He says most of the reforms introduced by the current government are geared towards improving governance.
“Over the longer term, certainly in the last 20 years, improvements in governance have been driven by regulations, greater institutional ownership of shares especially by foreign owners, generational changes in some families, and more professional senior managers with backgrounds in multinational corporations in indigenous companies.”
The First State Indian Subcontinent Fund has a slightly confusing history. There was another, popular First State Indian Subcontinent Fund, which is now run as the Stewart Investors Indian Subcontinent Fund, newly re-opened to investors after a period of soft-closure. However, the existing First State fund has built up an equally impressive track record, sitting over 60% ahead of its benchmark over five years.
Agarwal’s approach is to be benchmark-agnostic, with a capital preservation and absolute return focus. The team is bottom-up and research-heavy in its approach, placing emphasis is placed on company visits and meeting management teams. The portfolio is concentrated, holding around 50 names, giving it a high active share. The fund can also invest outside India in Bangladesh, Pakistan and Sri Lanka.
Today, this approach leads it to domestic consumer and private financial companies, as well as to suppliers on the country’s infrastructure projects.
Within financials, the group holds HDFC Bank and Kotak Mahindra Bank; the Indian subsidiaries of global consumer giants Nestle and Colgate-Palmolive also feature among the top 10 holdings. However, the group also holds domestic names such as Godrej Consumer Products, which makes soap, hair colourants, toiletries and liquid detergents.
Agarwal says: “We see things evolving in every sphere of business. On one hand the level of innovation has increased the opportunities available for investors whereas on the other hand, it has also caused disruption for incumbents.”
However, that doesn’t mean chasing every new and exciting idea: “As we focus predominantly on capital preservation, for now we are more focused on finding the impact on our holdings of the continuous innovation rather than trying to predict the future a decade down the line for new businesses which are as yet heavily loss-making.”
Reduced exposure to small and mid-caps
Historically, the fund has historically incorporated a higher weighting in small and mid-caps, but this has been pared back over the last year.
Agarwal says: “We reduced our exposure to small and mid-caps as valuations had become expensive – however, we are now selectively finding valuations more reasonable. We continue to have a high cash position which feels prudent while valuations are high and while several global risks are present.” He is not dogmatic about valuation and will pay more for a name with significant growth potential.
Agarwal started on the fund in 2012, so the five-year performance – 158% versus 95% for the wider sector – is his own. Naren Gorthy was brought into to work alongside him in 2017.
The fund has generally fallen less than the wider FO Equity-India sector during periods of market weakness.
Over the past 12 months, for example, the fund has dipped 6.9%, but the wider sector is down 11.3%. The same was true during the tough markets of 2015.
2019 is a significant year for India, with general elections coming up in April and May. While Modi is expected to be returned to power, it may be with a smaller majority and a weaker mandate.
Indian stock markets still reflect considerable optimism, which may be misplaced if reform momentum slows.
In this scenario, the more defensive positioning of the First State Indian Subcontinent fund may prove to be prudent.