2023-05-22 15:47:06 ET
Summary
- India is currently experiencing 3 strong growth catalysts that should drive GDP outperformance.
- Legacy investment issues like a weak Rupee and mixed relative competitiveness are slowly improving.
- India is a young, exciting country with tremendous human capital and a straightforwardly bullish economic outlook.
- A combination of 2 ETFs is our favored capital allocation strategy. With this, global investors can maximize reward while minimizing risk.
India has long been on the radar of savvy investors across the globe. The country has unbelievable demographics, improving physical and digital infrastructure, and a long and storied cultural history.
However, until recently, it has been difficult to justify an investment into the growing economy. While the country is poised to follow a similar trajectory of industrialization as its Asian neighbors, various factors have been holding the country back, including corruption, a weak currency (affecting USD-denominated returns), and poor human development index scores.
As India recently moved into 5th place globally in terms of GDP, leapfrogging the United Kingdom, we thought it prudent to check in with the nation to see how things were progressing.
After some research, we think the country is quite investible. Sure, there are still issues like endemic corruption, but structurally, the "bones" of the country are great, and support long term GDP growth and outperformance.
We believe that the country is at an inflection point from an economic perspective. Today, we will explore the three main catalysts that have made it an attractive time to invest into the country.
Demographics
As we mentioned, favorable demographics remain one of India's strengths. This year, the country will pass China as the world's most populous; a simple measurement, but one that actually has far reaching consequences. As the world's most populous nation, India's large and still-growing labor pool will allow the country to remain globally competitive in terms of the cost of labor for years to come.
This should invite strengthening foreign investment into low wage jobs like manufacturing, something that India needs a lot more of.
This change in standings doesn't stand in insolation, however. Hidden inside that data point is the less well-known fact that China's population has actually begun to shrink. 2022 was the year of China's peak population:
This has a whole host of knock-on effects, the main one being that China will see its price of labor become increasingly unaffordable to global manufacturers.
This is likely why the country is trying to become an advanced, high-tech economy. However, make no mistake; China's main global export is still goods and not services - Chinese tech firms have struggled to grow into international markets.
Michael E. O'Hanlon from the Brookings Institution, a Think Tank, had the following to say about China's depopulation:
The curves displaying their population trajectories over time have very different shapes. China’s population is, in fact, already declining. Its population will likely decline faster and faster in the decades to come — even if the PRC government has other wishes — because Chinese citizens are already choosing to have far fewer babies than had been expected when the earlier one-child policy was gradually relaxed, then lifted, in the last couple decades. Those trends can be expected to continue in a society that is becoming richer, and more expensive, and also has a gradually improving social safety net and retirement system. Indeed, according to current projections, China’s population is likely to drop below 1 billion by 2080 and below 800 million by 2100.
In short, India is becoming more and more relatively attractive, demographically, vs. its main competition. As a relatively young, growing country, it's likely India will outperform other countries in terms of GDP growth, which is the main driver of stock market returns in the long run.
Friendshoring
Demographic trends are great, but population and cost of labor alone isn't enough to structurally change the character of a nation's productive capacity for the better.
For that, we need to look at a recent trend called "Friendshoring". While different media outlets have a number of names for this, the basic idea is that companies want their operations to be based in places that don't look like they will be prone to geopolitical disruptions. For companies with a significant presence in China, this no longer looks to be true, as the country has become more adversarial vs. the U.S. in recent years.
If China invades Taiwan, then the U.S. will almost certainly sanction them, if not become involved in a direct kinetic conflict. This would wreak havoc on businesses with supply chains, personnel, or other operations in the country's borders.
This may have seemed like a far-fetched risk in 2021, but Russia's invasion of Ukraine in 2022 changed the risk calculus significantly for many global corporates.
To mitigate this risk, companies are increasingly making moves to relocate to more friendly, democratically aligned jurisdictions. India is an early frontrunner to inherit some of the benefits, due to its low cost of labor, democratic norms, good relations with the U.S., and strategic importance to the west.
But why would Friendshoring have such an outsized impact?
In the business world, it's largely believed that India "skipped a step" when it came to industrialization.
Typically, there are three "stages" of development: Agriculture -> Manufacturing -> Tech/Services. While China and other countries have been climbing the ladder in a linear fashion, India instead developed a two-tiered system. Agriculture remained the main form of income for most citizens, but in select cities, highly trained consultants, financial professionals, accountants, and engineers labored for better pay.
As a result, India has significantly reduced manufacturing capacity compared to its population vs. many of its neighbors, something widely believed to be a main constraining factor in GDP growth.
Should global corporations begin bringing manufacturing jobs to the masses, then more people will have more money to spend, and it could provide further fuel to the growth fire.
It's already happening, too. For evidence of this, look at all of the recent companies that have set up shop, like Foxconn, Samsung, and more .
More physical exports would also lead into a better balance of trade, which should improve the Rupee's strength relative to the Dollar, mitigating another one of our long-standing investment concerns.
Relative Fundamentals
Finally, India's internal economic leading indicators are simply stronger than most of the world right now:
In an environment where global growth looks like it's going to be mixed for the medium term, India's metrics stand out as a particularly bright spot.
With only one negative reading (that has a positive rate of change, anyway), India looks set to outperform its larger economic competitors over the next 6-18 months. These GDP implications should trickle directly into bottom line performance for stocks.
The Best Way To Invest
When you add it all up, we think the investment case for India is compelling at this moment in time. Solid relative demographics, strong 'Friendshoring' business catalysts, and an upbeat economic outlook all make it a compelling place to stash your capital for the foreseeable future.
So, what's the best way to invest?
If you're a U.S. investor, the easiest way to gain exposure is via ETFs. Here's a list of your available options:
Ticker | Name | Assets |
INDA | iShares MSCI India ETF | $4.7B |
EPI | WisdomTree India Earnings Fund | $834M |
INDY | iShares India 50 ETF | $589M |
SMIN | iShares MSCI India Small-Cap ETF | $255M |
FLIN | Franklin FTSE India ETF | 143M |
There are some additional funds, but they don't have significant enough assets or liquidity to be mentioned here.
Of these 5 options, we like a combination of INDA and SMIN the best.
INDA holds 70 companies, with a heavy allocation to India's top 10 companies like Reliance Industries, Infosys, and ICICI bank. This provides a concentrated bet on India's overall economy. It's also the lowest cost fund on the table.
However, in a growth environment, small cap companies are poised to offer the best returns as they have the greatest potential upside vs. their market cap. For this, SMIN is the best fund. Offering exposure to 240 smaller cap Indian companies, the fund is poised to outperform in the expected future economic conditions.
In terms of portfolio construction, we like a 65-35% INDA/SMIN exposure ratio best, in order to maximize reward and cap volatility.
Risks
There are some risks to this thesis.
Pakistan is becoming more and more unstable by the day as a result of the country's crushing debt burden, a recent flood which caused a massive economic and human toll, and massive political issues surrounding former prime minister Imran Khan. Pakistan is a nuclear-armed country and has historically not gotten along with India. If the situation deteriorates, then it's not clear how things would shake out.
India also faces issues at home. Corruption is still a big problem, as it hurts the perception of rule of law, sucks resources out of the economy, and introduces instability to foreign investors.
Finally, India could suffer internal monetary or fiscal crises that we haven't touched on here. India's debt to GDP ratio is higher than ideal, if sustainable, and the central bank could make mistakes that harm growth, although their track record is fine so far.
Summary
India has long been a promising country for investment, but as a result of recent catalysts we believe the time is now to begin gaining exposure to this long term growth story.
For further details see:
INDA And SMIN: Why It's Time To Bet On India