01 Jul 2019
I recently attended the Stewart Investors Sustainable Funds Group Forum covering investment in the Indian subcontinent. It certainly got me thinking...here's an overview from scandal and disaster to rapid urbanisation and outstanding returns.
Many investors are put off investing in India due to top-down uncertainty. Elections by their very nature create uncertainty. However, the Stewart team believe that democracy and long-term shareholder returns are linked as they result in a society with stronger adherence to the rule of law. The team believe that, in India, companies succeed despite politics and politicians.
India has had its fair share of problems in recent years such as towns suffering from pollution, Tsunami’s and flooding, together with other natural disasters and terrorist attacks. Scandals in India are commonplace, typically involving corporates involved with or influenced by politicians. Despite this, India continues to make steady progress as a nation. In 1998 the population was around 1 billion and has grown to around 1.4 billion today. GDP per capita has increased from US$699 to US$1,964 and there has been a significant fall in the adolescent fertility rate from 74 to 25 births per thousand. All this has helped child mortality decline from 99 per thousand live births to 39. Today 86% of births are attended by a health professional, compared to only 42% in 1998. Life expectancy at birth has increased from 62 to 68 years. Gender inequality has also fallen from 0.69 to 0.53 and the expected number of years of schooling has increased from 8 to 12 in this period.
The Stewart team have looked at returns from the Indian market since March 1996, a date deliberately chosen as it was pre the 1997 Asian crisis and so includes this hit. Amongst markets in Asia, India leads the way with annualised returns of 9.4%. This means that $100 invested in the Indian stock market index will be worth $784 in March 2019. India is a market which has volatility and risk like all others in the emerging world and the focus of Stewart Investors in this market, as in all others, is on capital preservation. It is easy to forget that if an investment suffers a 50% loss it must then see a return of 100% to get back to its original value. Stewart Investors believe India is a particularly good market for active investors and especially those companies who consider what can go wrong. Risk is viewed as loss of capital rather than underperformance to a benchmark.
Stewart Investors believe that there are many good reasons to invest in the Indian subcontinent. It is home to 25% of the world’s population. A large proportion of society still require access to basic goods, services and infrastructure and patient long-term capital can play a key role in helping sustainable development. In India there is a rich universe of high-quality listed companies with long histories and throughout the region, in general, there is rule of law with checks and balances. India now has companies that stack up extremely strongly by international comparisons. These include Financials HDFC and Kotak Mahindra Bank, Godrej Consumer Products, Dabur and Marico in the consumer space, together with holding company Murugappa which is a conglomerate and Tata Consultancy Services in IT outsourcing. Many of these businesses have delivered outstanding US$ 20 year returns with earnings growth. For example, Kotak Mahindra Bank compounds at 27% per annum with an investor return of 38% per annum over this period. HDFC has delivered 21% per annum to its investors, whilst in the consumer space, Godrej has delivered returns of 32% p.a. Marico has delivered 24%pa. and pays its farmers overnight which helps their working capital requirements.
Within the portfolio there are also several up and coming businesses such as BRAC Bank in Bangladesh, a country around 20 years behind India in terms of development, and other smaller, less well-known names in India such as V-Guard, Pidilite, Dr. Lal Path Labs and Info Edge. V-Guard is an emerging leader in home appliances, while BRAC Bank is Bangladesh’s leading financial institution focused on SMEs. Dr. Lal Path Labs is India’s leading pathology testing service, whilst Info Edge is India’s leading job and property classified’s company. Mahindra Logistics is the country’s leading third-party logistics supplier. These names all have a market cap below US$4bn and are an example of some of the smaller up and coming businesses within the region. This type of stock is rarely bought for more generalist Asian funds as they are not liquid enough to enter large mandates.
Companies selected for the fund have seen many economic cycles, are proven over time and have been able to prosper in a difficult external environment. Rule of law in India provides checks and balances on politicians despite the country being hit, as have certain corporates, by scandals from time to time. The strength of some of the Indian companies is demonstrated by the fact that HDFC has only lost 10bp per annum in loans over the last decade.
The Sustainability team take social and environmental issues into account when investing, arguing that this will involve major blow-ups further down the road. Urbanisation itself can bring problems such as traffic pollution and the team believe that engagement is an important factor. This is much more difficult if an investment business is not actually a shareholder.
Digitalisation and the growing penetration of mobile phones has changed the face of Indian banking. 96% of the population in the coastal regions of India now have mobile phones and 25% have smartphones. In four years, internet use has grown exponentially with around 30% of the population having access to the Internet. Companies such as Reliance Jio are a service provider with very cheap rates. India now has one of the lowest Internet tariff charges in the emerging world and globally. An important development has been Aadhaar Digital Social Security. Every citizen now has a digital social security number which has reduced fraud within the system. India has developed its technology eco system in a different way to China as it’s centralized and controlled by the government rather than private businesses. The country is also benefitting from increased usage of digital online payments for the poor and small cash payments are now generally digital. These changes occurred in Q4 2016 around the time of de-monetisation.
The private sector banks are much better placed than state owned ones to grow their loan books as they have a stronger and faster growing deposit base and much lower levels of non-performing loans. In India the state-owned banks have been forced to make poor loans by political influence, but this hasn’t happened at the high-quality private banks such as Kotak Mahindra Bank. The state-owned banks have stressed assets. Kotak Bank has 17% capital adequacy. Dipak Gupta, Joint Managing Director of Kotak Mahindra Bank explained that this long-term, favourable picture for the private sector banks is likely to continue as they have better capital adequacy, low levels of stressed assets and a better cost base due to investment in technology being driven by customer acquisition of digital products such as Kotak’s 811 digital bank account. In India it is now possible to open a new digital bank account in less than five minutes, whereas previously it took 5-7 days. This has meant that many millennials in non-urban or Tier 2/3 cities now have access to banking. In India a third of millennials own a smartphone but a digital bank account can be opened without this. Deposit growth is also digitally driven in India today. An online banking service has been priced competitively both on the loan and deposit side creating a virtuous circle. Kotak Mahindra became a bank in 2003 and now has a market cap of around $6bn. It also has financial services subsidiaries which are all 100% owned by the parent. In India banks are not under political influence which is a significant plus point. Kotak has no ambition to be the largest bank in India but wants to continue to do what it does well. It remains a family run business with the founder having been involved for over 30 years. The bank has a great reputation, both in India and in other parts of the world and it has been rumoured that Warren Buffet is interested in buying a stake in the bank.
Whilst much is written and read about Chinese urbanisation, India is on its own rapid path and Delhi is forecast to overtake Tokyo as the world’s largest city by 2030. Dhaka in Bangladesh is forecast to have a population of 28m whilst Mumbai in India is forecast to have a population close to 25m in 2030. Whilst China’s urban population is currently larger, India’s growth rate of urbanisation versus China is forecast to accelerate and Bangladesh is growing quickly from a small base. This rapid growth is proving challenging in terms of sustainable urbanisation with pollution increasing and air quality levels becoming poor on the subcontinent. Cities bring waste; Mumbai generates over 9,000 metric tonnes of waste per day and the number of motorised vehicles in Bengalaru (previously known as Bangalore) has increased from 100,000 to six million as the population has grown to 12.3m from 1.7m in the 1960s. The amount of land with vegetation has fallen from 63% to 23% and the city is now known as the one of ‘burning lakes’.
To lift people out of poverty further urbanisation is necessary and whilst urban areas in India account for 30% of the population, the remaining 70% only account for 15% of GDP. Mumbai and Delhi alone account for a quarter of Indian GDP. India has a very significant smog problem in its cities. Natural gas currently only accounts for 6% of total energy consumption but the aim is to increase this to 15% by 2030. Something called ‘bridge fuel’ emits 50% less carbon dioxide than coal when burnt. Compressed natural gas vehicles continue to increase. Domestic piped gas customers have increased at 21% CAGR in the National Capital Region in the past five years. Companies such as Indraprastha Gas are building up an ecosystem of intercity travel infrastructure, as well as supplying domestic gas.
As education in India improves so does the number of college graduates which is growing by 9m p.a., even faster than China’s 7.5m annual graduate output, and urban housing stock is increasing to support this. More and better homes provide a sustainable growth outlook for many successful businesses such as mortgage finance organisations HDFC and Delta Brac, whilst companies such as Asian Paints, Pidilite, V-Guard and Mahindra Life Spaces all benefit from this trend of urbanisation.
Thus, urbanisation on the Indian subcontinent presents both challenges and opportunities. One challenge is that there is not enough land available for development, whilst urban clusters provide better employment opportunities. Urbanisation growth rates in India and Bangladesh are now faster than China as their economies are less mature. India, as well as China, has air quality issues which, if not addressed, will affect life expectancy and health. Bangalore, the headquarters of the IT industry, was once a garden city. Urbanisation is necessary to lift the population out of poverty with rural India still seeing very low levels of GDP per capita with a population dependent on the vagrancies of the weather and lack of secure paid employment. Unfortunately, nine out of ten of the world’s most polluted cities are in the Indian subcontinent.
Indian urbanisation provides investment opportunities for additional sectors such as consumer and building products. V-Guard provides electrical appliances, fans and water heaters and offer a 10-year warranty with the aim of building brand loyalty. Pidilite is a leader in India in sealants, waterproof solutions, enhancements to cement and synthetic adhesives (Fevicol brand).
BRAC Bank is a leading private sector Bangladesh bank focusing on SME financing with a market capitalisation of around US$1bn. Selim Hussain, the Managing Director and CEO spoke at the forum. Mr. Hussain is a career banker and joined from IDLC Finance. He has helped the company deliver extraordinary financial performance over the past four years. Bangladesh as a country is 10 to 20 years behind India but has great catch up potential. Interestingly, outside of the Taiwanese Dollar, the country has the most stable currency in emerging Asia as it benefits from strong exports of textile products. Women’s place in a Muslim society has also been strengthened by the employment opportunities within this industry, despite the adverse publicity it attracts. Often in a Bangladesh household, women are the primary wage earner. Mr. Hussain believes that banking is 20-25 years behind India, but because of technology will catch up much quicker than this.
BRAC Bank is 18 years old and was started in 2001 to finance the world’s largest NGO which has an annual development budget of $1bn. The bank focuses on low cost SME banking and has an ROE of 19% – 20% and return on assets of 1.8x with capital adequacy of 14%. Its cost income ratio is reducing through investment in technology and people. BRAC does business differently from other banks in the country. For example, its SME and micro finance loan rates are not the typical 25% - 30% charged but 15%. Mr. Hussain explained that charging 25% to 30% was wrong and unnecessary as for BRAC Bank their non-performing loans to smaller customers are in fact the lowest of any part of the business.
This bank applies social criteria when lending and thinks about what ethics mean. The bank will not do business with people, companies or products which harm society or people. For example, BRAC bank won’t work with the tobacco sector which is significant in Bangladesh. Neither does it finance the ship breaking industry which has attracted a lot of criticism due to its unsafe labour practices and high fatality rates. BRAC does not lend to businesses using child labour. Companies not certified by the Department of Environment are not lent to. There is a focus on conducting business with companies exposed to the real economy and limited lending to other financial institutions. The bank has a focus on sustainability and environmental sustainability.
The bank believes that lending to small ticket customers at high rates is morally wrong and not beneficial to the customer or society. Mr Hussain describes this system as people before profit banking. The board is not run by big businessmen and the company is aiming to be the best bank in Bangladesh. This is a country where, at present. only 10% of the population have bank accounts so the opportunity is huge. In the long-term the bank wants to replicate the business model of Kotak Bank in India. Digital banking is providing strong growth and helping to address the lack of gender diversity in the customer base. It’s much easier for women to open bank accounts online. The bank is now making 10,000 SME loans per month with the digital element allowing rapid expansion. Mr. Hussain believes that the country can grow at 6-7% p.a. Large corporates are considered risky customers and are avoided as they often use political influence to defer paying back loans. The bank has launched a specific product for women which is lower in cost and offers a deposit option as well as normal banking and credit. Empowerment for women in Bangladesh is more prominent than in other South Asian countries. Mr. Hussain commented that the educational system in Bangladesh is a challenge and questions whether the skills necessary for the country’s growth will be promoted.
The Stewart Investor team take engagement very seriously and this was commented upon by several speakers at the forum, such as Mr. Hussain, Dipak Gupta, the Joint Managing Director of Kotak Mahindra, and Vellayan Subbiah, the Managing Director of Tube Investments India. Successful engagement takes time and depends on long-term relationship building with businesses.
The Sustainable Funds Forum provided an opportunity for investors to hear from some of the highest quality management in the Indian subcontinent. The businesses have delivered outstanding returns to investors over the longer term and have grown in a sustainable manner with a real focus on ESG considerations, not just box ticking. The Stewart Investor team have dual objectives; to provide excellent returns to investors with low levels of volatility and downside protection in difficult markets, to improve corporate behaviour. The team passionately believe that investing with a sustainability lens enhances shareholder returns in that large blow-ups resulting in permanent destruction of capital can be avoided. The forum provided an opportunity to hear this from company management who have actually delivered this to their shareholders.
This information is for UK Professional Advisers only and should not be given to retail clients.The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
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