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India: A Brave New Emerging Market

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Feb. 17, 2004 — India, long ignored by Western investors and overshadowed in recent years by the burgeoning economy of China, may have finally established itself as an attractive and profitable place to purchase stocks. As emerging markets surged in 2003, the number one international stock fund for the year was Eaton Vance Greater India Fund (ETGIX), skyrocketing 117.3%, versus 59.4% for the average emerging single-country fund.

As a potential target for American investors, India boasts a number of positive characteristics: attractive stock valuations, an increasing standard of living, rising industrial output, falling inflation, political stability, a well-developed banking system, improved corporate governance, robust capital markets, a strengthening rupee, and a huge, well-educated workforce.

As for the Indian market, the SENSEX, which comprises a broad array of 30 large stocks trading on the Bombay Stock Exchange, soared 73% in calendar 2003. According to the Times of India, foreign institutional investors poured in more than $7 billion into Indian stocks last year. This figure is expected to balloon to more than $20 billion in 2004.

Recent outperformance, and a positive flow of news, has seemingly made India the “flavor of the month,” said Ajit Dayal, deputy chief investment officer of Hansberger Global Investors and lead manager of the $1.8-billion Vanguard International Value Fund (VTRIX). “However, India is an attractive long-term growth story. Increasing consumption and demand for goods and services, and the need to add capacity across a diverse range of industries, provides stock pickers with a great menu of stocks to choose from.”

Todd Henry, a portfolio specialist at T.Rowe Price, noted that despite its surging returns, the Bombay Exchange still has an average 12-month trailing p/e of 19, and a 12-month forward p/e of only 15. “While stocks aren’t exactly cheap anymore, strong foreign buying may keep stocks moving in an upward trend over the short term,” he said.

After struggling through decades of modest 2% annual growth rates, India’s annual GDP has risen to the 6% level in the past ten years, driven by the government’s liberalization of the economy, loosening of controls, and recognition that foreign investments were crucial to development. The GDP is expected to grow 8% in fiscal 2004, and settle in at 7% the following year, Dayal stated.

However, typical of any emerging market, it should be stressed that risks remains high. Relative to its Western counterparts, Indian markets are small, illiquid, and not as well regulated. India, the second most populous nation on the planet, represents only a 6% weighting in the MSCI Emerging Market Free Index, and a minuscule 0.6% of the MSCI World Index.

To illustrate the embryonic nature of the Indian economy, consider that of more than 7,000 publicly-listed Indian stocks, about 6,000 have a market cap below $10 million. As a result, the vast majority of Indian equities barely qualify as microcaps, hardly the type of stock foreign investors want to buy. Local investors typically invest in the BSE-200 Index, which comprises 200 of the largest firms trading on the Bombay Exchange. Henry estimates there are 55 Indian stocks with market caps of at least $500 million.

Moreover, India has allowed foreign stock investments only since July, 1991, and foreign individuals still cannot invest there directly. Indian regulators developed a registration process for so-called Foreign Institutional Investors (FIIs) with its own strict rules and limitations. Of course, individual American investors may buy a limited number of Indian ADRs which trade on the NYSE or NASDAQ, including software firm Infosys Technologies ADS (INFY), which has benefited tremendously from outsourcing contracts from Western companies, and ICICI Bank ADS (IBN), India’s second-largest bank.

Another pitfall with Indian investing lies in the somewhat chaotic and archaic nature of Indian stock markets. Dayal points out that in the early days of foreign investing in India — roughly 1992-1994 — only paper share certificates were available to investors, a cumbersome and tedious record-keeping system with great latitude for mistakes and corruption. “Trades could take 12 months to settle in those days,” he noted. “However, the system has dramatically improved since. A new electronic trading system, The National Stock Exchange was established because brokers in Bombay Exchange resisted change, presumably to maintain high spreads between the bid and offer prices.” Though settlement times have been reduced now to three days, India has done a poor job in promoting and marketing its newly advanced trading system, adds Dayal.

The good news in India is that its equity markets are growing. For example, the country’s IPO activity, valued at about $1 billion in 2003, is expected to increase sixfold this year. Dayal believes the majority of these new stocks will be in oil, telecom and software. Indeed, planned public offerings by the government of shares of two state-owned giant oil and gas companies are expected to generate $2.5 billion by March. Consequently, more Indian stocks in float would likely raise the country’s weight in the MSCI indices, as well the nation’s global profile.

While it is tempting to compare India with its giant neighbor, China, the differences between these economies and cultures are dramatic and profound. For one thing, as exemplified by its proliferation of small upstart companies, India possesses a huge number of entrepreneurs. By contrast, almost every company in China is either state-owned or state-sponsored. In essence, the Communist government is itself that nation’s principal ‘entrepreneur.’ Only recently has Beijing introduced the profit motive into its corporate entities.

Henry noted, however, that India’s market movements are very similar to that of China. “Indian stocks perform well whenever there is euphoria about China,” he said. “Western investors view both nations as global economic giants with similarly tremendous potential. Both countries are receiving massive outsourcing contracts from Western companies, although, with China, it’s primarily in manufacturing, while India is getting services and software contracts.”

Fund Advisor identified only one open-ended, U.S.-based mutual fund investing exclusively in India, Eaton Vance Greater India/A (ETGIX), managed by Hong Kong-based Zaheer Sitabkhan. As of Dec. 31, 2003, the $53-million portfolio had 43 holdings. Reflecting the “old economy” nature of India’s business landscape, the fund is dominated by engineering/manufacturing, chemicals and metals companies. The fund’s average $2.89 billion market cap gives the portfolio a decidedly small-cap complexion.

For the three years ended 2003, the fund gained an average annualized 16.9%, versus 13.8% for the average emerging single-country portfolio. The fund features an expense ratio of 4.75%, more than double that of the peer group average (2.27%); and a turnover rate, 112%, a bit higher than the peer group (102%). The fund’s standard deviation of 28.6 is greater than the peer group average (25.8), making it even more volatile than the average single-country fund, and giving it a higher risk profile.

The $41-million Eaton Vance Asian Small Companies Fund (EVASX), also managed by Sitabkhan, has about 30% of it assets exposed to India. The portfolio soared 85.3% in 2003. As of Dec. 31, 2003, the fund had 87 holdings. Half of the portfolio is taken up by industrial, financial and consumer discretionary stocks. The fund has a 2.47% expense ratio, versus 1.96% for the peer group, and a turnover rate 112%, versus 146% for its peers. As of the end of December, the fund had 11.7% of its assets in Hong Kong, 6.5% in Korea, 5.7% in Taiwan, and 5% in China.

–Palash R. Ghosh


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