TelstraSuper prefers taking an overweight position to Indian equities over Chinese equities as risk of permanent loss of capital in China is higher.
Indian equities might be flavour of the month, but there are good reasons for institutional investors to have a structural, long-term allocation to the country, unlike China, Dominique D’avrincourt, Head of Equities at TelstraSuper, said at last month’s Frontier Advisors Annual Conference in Melbourne.
D’Avrincourt completed a research trip to India a few months ago as part of a broader research trip and had the opportunity to meet with a number of companies, including Indian bank HDFC and many founder-led businesses.
“I was very impressed by the entrepreneurial mindset. The businesses that I met all very strongly focused on not only improving societal outcomes for India and income for Indian people in general, but they also had a very strong focus on return on invested capital,” she said during a breakout session at the conference.
“I think that’s a key difference between India and China. China is very focused on growth and India is very focused on return on invested capital, which is a preferred metric of mine, just thinking about quality and long-term investment.”
I think that's a key difference between India and China. China is very focused on growth and India is very focused on return on invested capital, which is a preferred metric of mine, just thinking about quality and long-term investment
She also pointed out that in contrast to China, Indian retail participation in the domestic market is less volatile, partly due to the creation of the Systematic Investment Plan.
This plan is a vehicle offered by mutual funds, giving retail investors the option to invest fixed amounts of money at regular intervals, rather than investing a large amount all at once.
In practice, this means the market sees a steady inflow of capital, even at times when the equity market experiences a drawback.
“The Systematic Investment Plan, which the government put in place, means that people, mums, dads and anybody, can invest in the equity market. Currently, there’s about US$35 billion per annum going into the equity market systematically as people divert their savings into equity,” D’avrincourt said.
“In fact, last week, when the market was down 5 per cent when [Indian Prime Minister Narendra] Modi lost the majority [vote], there was US$3 billion of flows from retail [investors] that went into the market that day. It’s almost like a buy-the-dip mindset.
“I find that a very attractive component of retail investing in India versus China, which is very much non-contrarian and tends to move with the market. The sell-offs are exaggerated. When you have a sell-off in China, it is because retail exits the market.”
China
D’avrincourt is well known for her views on the Chinese equity market. About two years ago, she made a timely call that the market was getting crowded, while risks were rising on the back of greater geopolitical instability and troubles in the Chinese real estate market.
She decided to underweight China in the portfolio by a significant margin compared to the emerging markets (EM) benchmark, just before the sell-off started. Although Chinese equities have fallen a lot in value since that time, making them arguably a better investment today, she is still sceptical about a significant, long-term exposure to the country.
“There is no risk that you can price if the risk is permanent loss of capital. I don’t see China as a long-term investment. I know it’s fallen; the market fell from the time that I made that comment two years ago. I still think that the risks outweigh the benefits,” she said.
“From a long-term perspective, I don’t have comfort around governance and also the rule-of-party. I think the permanent loss of capital is always going to be a risk in China unless something drastic changes.”
Despite this view, she does believe investors can make money from taking a short-term allocation to the Chinese equity market as mispricings occur regularly. But even then, she is hesitant to put any member money to work in this space.
“I wouldn’t be using physical capital to do that. I would be more than just using futures to take some views here,” she said.
“Using ETFs (exchange-traded funds) or futures to play the beta is a good way to go in and out of the market, but I don’t have confidence in investing physical capital, our members’ money, in a long-term plan there.”
However, the same is not true for the Indian equity market, she said. Taking a long-term exposure here makes sense as there are structural drivers that are changing the economy, while the distortion of valuation by retail investors is less than in the Chinese market.
“I don’t think you can time in and out of India because all the short-term things tend to be more noisy. Last week, for example, Modi still had the majority. Now he just has less seats than he had before, [but] the structural agenda hasn’t changed,” D’avrincourt said.
“The reform agenda is going to get stronger. He will actually focus more on rural areas because that’s where he lost the vote. He’s going to be a bit more populist going forward and focus more on the economics and, for example, build more affordable housing in rural areas.
“The focus will shift a little bit on making sure that the poorer parts of India are better supported. I don’t think that will change the reform agenda as a whole, but perhaps spreading more to the wider population.”
Although many investors believe valuations in the Indian market look expensive, TelstraSuper has an overweight to the country, especially in Indian financials.
“We have a big position relative to the index in financials in India because that’s the sector that’s well placed to capitalise on what’s happening in the economic surge in India,” D’avrincourt said.
TelstraSuper recently appointed an EM manager to cover the region and although the fund didn’t go down the route of appointing a dedicated Indian equities mandate, it did contemplate this option seriously.
“We were pretty much tossing between finding a separate Indian mandate versus having an EM mandate with a larger India allocation. We went with the latter. The only reason being our size. It gives us more flexibility [as we grow],” D’avrincourt said.
But the fund did allow the EM manager to invest up to 35 per cent into India, well above the market weight in an EM index.
For example, the MSCI Emerging Market Index has an allocation of 18.1 per cent to India.
The Australian Prudential Regulation Authority does not have a separate EM benchmark, but uses the MSCI All Country World Ex-Australia Index for international equities and this benchmark includes India in its ‘others’ category, which has an allocation of just over 20 per cent in total.
“I don’t think you can invest in EM and be wedded to the benchmark, so we’ve instead appointed an EM manager with a 35 per cent leeway to invest in India, which is a significant deviation from the benchmark,” D’avrincourt said.
“You have to have an absolute return mindset with that type of mandate and you cannot pay performance fees. That would be a killer.”
If it was up to me and we had no benchmark, I'd have zero China. I would be very comfortable having no investments in China, but we actually have to manage to our benchmarks. We are underweight China by quite a bit, but having zero is a pretty big call
James Gunn, Head of Equities at Frontier Advisors, chaired the EM session at the annual conference and observed allocations to EM across the asset consultant’s client base had been falling in recent years.
“The year-on-year trend is that the strategic allocation to EM has absolutely come down quite meaningfully over the last few years. Now, probably for very understandable reasons, EM has been a really challenging area,” Gunn said.
“From a beta perspective, you’ve got the China concerns, but probably less appreciated is the impact [of EM] on the fund’s active risk budget. The dominance of EM is taking up [a large portion] within that allocation.”
He also mentioned some clients were considering an EM ex-China allocation, although no fund had actually implemented such a mandate yet.
“We’ve seen a lot of discussion around the notion of EM ex-China. It’s been talked about as being the fastest-growing asset class, at least by one manufacturer, and I’m sure that is the case,” he said.
“[But] we haven’t seen too many clients move past the conceptual stage around this. For most clients, we still believe that a dedicated EM, single umbrella, high-quality manager is the right way to go, but we’re also very open to the fact that there are specific reasons for clients to express another view.”
D’avrincourt added she would consider an EM ex-China mandate if the fund wasn’t subject to the Your Future, Your Super performance test and its benchmarks.
“If it was up to me and we had no benchmark, I’d have zero China. I would be very comfortable having no investments in China, but we actually have to manage to our benchmarks,” she said.
“We are underweight China by quite a bit, but having zero is a pretty big call.”
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