Ashoka India Equity delivers (4.3%) NAV return in tough year for India

Ashoka India Equity (AIE) has released year-end results for the 12 months to 30 June 2020. Over the period, which marks the company’s second annual results release since its launch, the total returns generated by the NAV and shares were (4.3%) and (9.6%). By comparison, the benchmark MSCI India IMI index delivered (16.0%).

India has underperformed

AIE’s manager notes that the benchmark underperformed global, developed, and emerging markets. The S&P 500 has returned (in GBP) +9.6%, MSCI World +5.5%, and the MSCI Emerging Markets was down 0.9%. Crude oil prices declined by 36.6% and the Indian rupee depreciated by 5.8% during the year. Among sectors, communication services and healthcare outperformed whilst industrials and financials underperformed.

The major contributors and detractors to AIE’s performance are shown in the tables below: 

Outlook from Acorn Asset Management, AIE’s manager

“The past six months have witnessed one of the most volatile markets in at least a decade. A precipitous decline in March was followed by a sharp recovery during the second quarter not only in India but globally.

India underwent one of the most stringent nationwide lockdowns in the months of March and April. During May these restrictions were gradually relaxed due to the severe impact on India’s economy. Subsequently, June saw further major relaxations of restrictions. A gradual normalisation of economic activity is currently underway in most of the country. At the same time, we now live with the sobering reality that the number of infections is steadily rising, with India having the second-largest case count following the US. As is the case globally, the government and policymakers continue to face a difficult choice between lives and livelihoods.

Over the last three months, the COVID-19 pandemic has morphed from being an unknown unknown to a known unknown; from being an unknowable risk factor that took the world by surprise to one that we are now aware of but don’t fully understand yet. With each passing day the world is learning more about the virus. COVID-19 has proven to be far more contagious than initially thought, affecting an ever-increasing number of people across hemispheres. However, mortality rates seem to be lower than previously feared, partly aided by an increased understanding of the disease and of the several ways to mitigate its impact on those affected.

By now it is generally agreed that the actual case count of infections might be far higher than the reported numbers in most countries. We believe India is no exception. There are a set of numbers and projections based on reported case counts, hospitalisations, recoveries, mortality, and their past and projected growth rates. On the other hand, there is a certain absolute reality of all these parameters and their trends that could be widely different from the reported numbers.

The uncertainty is still too high to have any reasonable degree of confidence on how things are likely to evolve over the next 12-18 months. In our loosely defined base case scenario, we believe either herd immunity will be achieved in India in the next 6-12 months or a vaccine would become widely available and administered in the latter part of next year. We do not expect a re-imposition of any large-scale lockdowns as these failed to effectively contain the spread even as they aggravated economic hardships.

Under such base case scenarios, it is possible that the Indian economy contracts mid-single digits and corporate earnings may further decline during the current year, broadly in line with consensus.

The Indian government announced several rounds of economic stimulus amounting to circa 2% of GDP, primarily aimed at providing income support to vulnerable segments of the population and addressing survival needs of small businesses. The Central Bank simultaneously stepped in with large liquidity infusions and multiple interest rate cuts. India’s benchmark policy rate stands at 4.0%, down 115 bps since the outbreak of COVID-19.

In addition, the government announced several initiatives to garner a greater share of global manufacturing as corporates around the world look to diversify their supply chain beyond China. This can further accelerate the growth trends in manufacturing industries such as consumer durables, electronics, and speciality chemicals amongst others.

Unlike most other emerging markets, India benefits from the fall in oil prices, given that it imports over 80% of its requirements. At current levels, with Brent crude prices of around $40/bbl, India is expected to save approximately US$30 billion annually, and consequently, the Current Account Deficit (CAD) is expected to turn positive. The fiscal deficit is expected to inch up to 7.1% in 2021 from 4.5% in 2020, largely on account of revenue shortfalls and a smaller denominator effect due to GDP contraction. However, a low external debt to GDP and over $500 billion of forex reserves are supportive of a stable macroeconomic environment.

Despite the uncertainty, several companies were able to raise large sums of capital from the equity markets. Collectively, Reliance ($22 billion), HUL ($3.4 billion), Kotak Bank ($2 billion) and Bharti Airtel ($1 billion) have seen over $25 billion of transactions.

Another development was Moody’s downgrade of India’s sovereign rating by a notch to Baa3, bringing it at par with S&P and Fitch which are both rated BBB-. Empirical evidence suggests no observed historical correlation between a country’s sovereign rating downgrade and subsequent equity market returns or investment flows.

In geopolitical developments, tensions escalated between Indian and Chinese troops along the northern border with several casualties on both sides even without any shots being fired. As we write this, the situation appears to be de-escalating after several rounds of high-level talks on a roadmap to disengagement.

In continuation of its reform agenda over the years, the government has announced some major agricultural and labour reforms. The agricultural reforms entail substantial deregulation of production, supply, distribution, and prices for agricultural commodities, in essence liberalising India’s agricultural markets that have long been shackled by regulations that hitherto remained untouched due to political sensitivity. If implemented as announced, this reform will go a long way in transforming India’s agricultural economy.

Our investment philosophy of seeking compelling combinations of great businesses at attractive valuations with strong portfolio risk management has placed us in good stead in the current environment. For the most part, our portfolio comprises of industry leaders, dominant players or companies that are gaining market share in their respective industries on the back of strong execution. These businesses typically have superior returns on invested capital, robust cash flow generation, and resultantly strong balance sheets. We place great credence on the resilience of their operating models and the ability to quickly adapt and thrive in the altered paradigm caused by COVID-19. During a crisis, when weaker competitors may struggle to survive, we expect our companies to emerge stronger through it.

In closing, we remain cautiously optimistic and continue to believe that the structural growth drivers of the Indian economy are deep-rooted and, near-term challenges notwithstanding, India presents an attractive long-term investment opportunity.”

AIE: Ashoka India Equity delivers (4.3%) NAV return in tough year for India