How should investors access Chinese and Indian growth?
The Chinese reforms starting in 1979, the fall of the Berlin Wall in 1989 and the Indian reforms starting in 1991 were important economic milestones that will have a lasting impact on the global economic landscape in the 21st century.
Opinions may differ, from an admiring Thomas Friedman in The World is Flat to critical economists decrying the income inequality and environmental costs, but China and India have become the most attractive markets, for investors, for marketers and for service providers. Within them, China has a clear edge with the sheer scale of its manufacturing might, its ability to produce goods at massively lower costs and its investment led growth economy.
India, with its democratic framework and pluralistic divergences, has been left behind on the infrastructure and manufacturing fronts, while on the services platform, it has found a niche built on its IT-based comparative advantages.
For private investors, China represents a strong growth story and ranked number one on the AT Kearney FDI Confidence Index from 2002 to 2010. Potentially, the biggest risk is
of social instability with a single party dominated polity controlling the entire space. India has slipped from second ranking to third on this index over 2005 to 2010. Similarly, on the World Economic Forums Global Competitive Index, China was ranked 27th in 2010 vs India at 51st.
What is clear is that an investor seeking growth and diversification needs to be invested in both China and India, but with a clear understanding of the risks these markets carry. It is critical that the investor have clarity on the exit options and on the shallowness of these markets, which may render any investment illiquid in a very short time frame.
So why do we recommend India, albeit as a small portion of an investor’s portfolio? The pluses are manifold. India is the 11th largest nominal economy, the fourth largest purchasing power parity economy and the world’s largest democracy with an established legal-judicial system and intellectual property rights protection. It is a growth economy with a young demographic profile, abundant natural resources and skilled human resources available at low costs with the backing of a strong regulator. Corporate governance is rated high by analysts and balance sheets are strong. With limited infrastructure and low consumption levels, this represents a huge opportunity for investors to benefit from the economic build out that India will witness in the next two decades.
We are also looking at a strong growth story in India – attributed to the big market of affluent, mass affluent and emerging affluent in India. Wealth generation in the economy is huge and most of the Indian billionaires are first generation wealthy with the list set to grow exponentially over the next few years.
To this end, $500bn is saved per annum and is growing at 15 to 17 per cent per year. The opportunity for wealth management providers in India is huge.
In terms of sectors, the big themes will be infrastructure development, consumption boom and urbanisation with an increasingly affluent middle class. Sectors serving these themes or driving them will stand to benefit.
There are a number of ways to access the India story. Nearly all sectors are open to foreign investors. There are many India-focused funds, both in the mutual fund and hedge fund space that give exposure to Indian equity markets. Similarly, many Asia and global emerging market funds and private equity vehicles provide easy exposure to the India story.
Investors must be willing to stick to their convictions for the longer term to unlock the true value of their ventures into India. In March 2011, the Sage of Omaha, Warren Buffet, finally visited India and put it thus: “Better late than never.”
China
Ivan Leung
Chief Investment Strategist, Asia at JP Morgan Private Bank
The IMF projects China’s GDP (in purchasing power parity) terms to overtake the US’ by 2016. In US dollar terms, economists forecast that it will overtake some time after 2020.
How China gets there will be a challenge, given short-term inflation problems and hard landing risks, to medium-term threats of a property bubble, to long-term challenges such as commodity needs and the transition to a consumption-based economy. In addition, there are further political, social and environmental challenges.
Even if China successfully overcomes all major obstacles, the more pertinent issue for international investors is whether they can profit from her growth. It is commonly said that stock returns and GDP do not move together and the industry makeup of the equity market can differ substantially from the economic structure. However, over the last decade, there was a good relationship between successful economic growth and greater stock returns. China’s stock returns were high, but considering the incredible economic growth, the performance was disappointing in comparison to India or Indonesia.
Part of the problem is that state-owned enterprises (SOEs), unlike the private sector, may have objectives other than generating profits. They may also be less innovative and productive. SOEs have consistently lagged the overall growth of industrial enterprise profits.
The number of SOEs in the industrial sector has declined in recent years from representing 40 per cent of Chinese industrial companies in the late 90s to less than 5 per cent at the end of last year. But, for equity investors, SOEs represent 80 per cent by market cap of the investable stock market (MSCI China).
This is not to argue that SOE stocks are poor investments, it is simply to highlight that they won’t capture the economic opportunities as effectively as private companies. Private firms can offer much more upside, but may also have transparency problems. For equity investors who are worried about fraud, buying international companies that derive significant sales from Chinese growth makes sense. For more direct exposure, even though MSCI China is largely made up of SOEs, the index currently trades inexpensively against its history and at a discount to the region.
Actively managed funds and hedge funds are good ways to play the market. With resources to analyse companies more closely, good fund managers can produce excess returns, and talented hedge fund managers can deliver alpha and superior risk-adjusted performance. Private equity offers access to private companies, and they can acquire stakes at valuations cheaper than public markets.
From a currency perspective, the offshore renminbi offers appreciation potential with low risk. We expect the undervalued renminbi to appreciate at a 3-6 per cent pace versus the dollar. Commodities meanwhile are an obvious asset that benefits from China growth. Given very difficult supply vs demand conditions in coming years, we are particularly favorable towards copper and oil.
It’s frequently asked whether India or China offers greater investment potential. I strongly believe that it doesn’t have to be an either/or. India is in many respects 10 years behind China from an economic perspective, but the quality of the private sector (as represented in its stock market) is superior. We are cautiously positive on both countries, as equity valuations are inexpensive and we forecast that inflation issues will gradually abate. That said, MSCI China is currently much cheaper from an absolute and relative basis than MSCI India.
We are positive on both the renminbi and rupee. However, the advantage to investing in the renminbi is that it is strongly supported by trade fundamentals, political pressure to appreciate and the trend for China to develop greater domestic consumption. Given its extremely low volatility, the renminbi offers superior risk-adjusted return potential.
