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Aberdeen New India underperformed despite epic rebound

Aberdeen New India (ANII) has released its annual results for the year ended 31 March 2021, during which its NAV has seen an epic rebound from its March 2020 lows (it provided an NAV total return of 52.7%), although it underperformed its benchmark, the MSCI India Index, which rose by 59.1% (all in sterling total return terms). However, assisted by a narrowing of its discount from 20.3% to 13.6% over the year, ANII provided a share price total return of 65.6%.

Market review

The year under review saw a marked recovery for Indian equities as the market rebounded from the multi-year lows witnessed after Covid-19 struck in early 2020. In March 2020, India went into a strict lockdown to curb the spread of the pandemic. This brought a sudden halt to business activity that saw India’s GDP numbers collapse to historic lows. ANII’s managers say that this decline was made worse because economic growth had started to flatten in the preceding quarters. However, the authorities responded with unprecedented monetary easing and fiscal stimulus to support those hit hardest. By October 2020, infection cases had receded and social-distancing measures were eased, allowing for business activity to restart. This, together with good monsoons that supported rural spending, led to optimism for corporate earnings recovery. Further good news came with the vaccine roll out towards the end of 2020, followed by a pro-growth budget in February 2021. However, towards the end of March 2021, infection rates spiked once again, resulting in fresh localised lockdowns. This has prompted the central bank to continue to adopt an accommodative monetary policy, despite inflation fears from a rebound in oil prices.

Portfolio

Not surprisingly, the pandemic has made winners of some Indian companies, while others have faced their toughest test for many years. ANII’s managers say that, among those which benefited from rising adoption of cloud computing, increased remote working and accelerating digitisation were ANII’s holdings in the information technology services sector, where the portfolio has a large exposure. Mphasis contributed to returns as it clinched record contract wins with businesses turning to digital transformation solutions. In communication services, Affle India, an ad-tech holding that was newly introduced during the year, also posted impressive share price gains. ANII’s managers say that, as the dominant and profitable data platform provider for direct digital advertising in India, the company benefits from the rise in digital adoption, mobile and e-commerce penetration in the country. The managers believe that India offers exciting growth prospects in the internet space, but comment that there are limited opportunities in the listed universe. This makes Info Edge another interesting addition to the portfolio. The managers describe Info Edge as the leading online classified advertising business. They say it has a dominant position in recruitment and real-estate search. It also has a profitable and cash flow-generative business that has enabled it to build up a portfolio of technology-based start-ups.

In addition, businesses that have been more leveraged to a cyclical recovery outperformed during the period. In this regard, ANII’s higher exposure to Consumer Staples, namely Nestle India and Hindustan Unilever, and a more defensive positioning within Financials via Kotak Mahindra Bank meant that portfolio returns did not keep pace with the market’s strong rally. However, the managers say that they continue to favour these high quality holdings that deliver consistent earnings through cycles. They believe this will enable ANII to maintain resilience even as India heads into another period of uncertainty with the ongoing resurgence in Covid-19 cases.

ANII’s exposures to real estate and construction were among the key performance contributors. Although both sectors were among the worst hit at the peak of the pandemic in March 2020, ANII’s investments in what the managers says are the industry leaders has provided positive returns. These companies have delivered growth ahead of beleaguered rivals that had suffered a liquidity crunch stemming from the lockdown. In this regard, the leading residential developer Godrej Properties enjoyed healthy pre-sales growth thanks to its well-established brand and reputation among homebuyers. Although the recent spike in infections may once again have a near-term impact on sales, the managers say that, in the long run, structural demand in the real estate sector should benefit from a conducive environment of favourable housing policies and low-mortgage rates. In addition, Godrej Properties is a prime beneficiary of industry consolidation. With its funding advantage and operational capability, the company is upbeat about acquisition opportunities that the managers believe will enhance its land bank.

UltraTech Cement also delivered better-than-expected results. It actually gained market share and demonstrated pricing power, being one of the few companies with the financial strength to expand capacity. Industry fundamentals are expected to strengthen with the pick-up in construction activity, driven by the improving housing and infrastructure cycle. The managers say that the latter has been a long time coming and may finally be on the cusp of an expansion with the government reaffirming its commitment to infrastructure spending.

During the year, the managers added a new holding in Larsen & Toubro that they say is likely to benefit from the government’s push for more infrastructure and affordable housing. Elsewhere, India’s energy transition is stepping up and the government is committed to more investment in renewables. The managers believe that Power Grid, a national power transmission firm in the utilities business, also introduced during the year, stands to benefit. They say that this public sector enterprise is prudently managed and has a healthy operational cash flow, backed by a robust balance sheet. Gas also has a major role to play as a cleaner fuel substitute. Holdings in gas distributor Gujarat Gas and integrated gas and liquids logistics player Aegis have gained as a result.

ANII’s managers say that the good performance in these two holdings compensated for their decision not to invest in Reliance Industries. Reliance Industries’ shares surrendered some of their earlier gains following weaker third-quarter results, a cautious refining and petrochemical outlook; and execution challenges experienced in its new consumer business. The managers say that, within Reliance’s business portfolio, the brightest near-term prospect may be in its telecommunications division. This is because the industry is now going through market repair and consolidation after a tough operating environment brought on by a debilitating price war. For this same reason, the managers have re-introduced Bharti Airtel to the portfolio. They say that it remains the leading telecom service provider with a pan-India reach and sophisticated customer base with higher average mobile spending.

In terms of other disposals, Lemon Tree was sold at the start of Covid-19 as the company was entering a challenging period for the hospitality sector with sizeable debt on its balance sheet that would have generated financial stress. Grasim Industries was sold so that the managers could focus ANII’s cement exposure in its subsidiary Ultratech Cement, which the managers believe offers a more direct exposure to housing and infrastructure spending. In a similar vein, the managers exited Kansai Nerolac and focused ANII’s paints exposure on industry leader Asian Paints. Profits were also taken in Hero MotoCorp and Varun Beverages. The managers say that, following robust share price performances, both companies share prices had started to reflect unrealistic expectations of growth.

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