India seen emerging more from shadow of China this year

The ranks of institutional investors turning to Indian equities for a shot of portfolio adrenalin could swell this year, attracted by the subcontinent's world-beating growth prospects and some geopolitical tailwinds, money managers say.

On Feb. 15, AustralianSuper, the A$260 billion ($189.5 billion) Melbourne-based superannuation fund, got to the front of that line, announcing plans to retain its first India-dedicated external manager. AustralianSuper's initial allocation to the country is likely to be modest, but it will grow over time, a spokesman for the fund said in an email.

Money managers predict more asset owners will follow suit.

"India could easily (claim) a dedicated space in a lot of institutional portfolios," predicted Arjun Jayaraman, a director, quantitative portfolio manager and head of quantitative research with Los Angeles-based Causeway Capital Management LLC.

"Long term, if you're an institutional investor looking for some growth in your portfolio, India is one of the few places that offers it" now, Mr. Jayaraman said. Causeway, which reported $45.2 billion in assets under management as of Dec. 31, is working now on launching a commingled India fund for institutional investors.

Analysts say the combination of a young demographic profile, a reform-minded prime minister in Narendra Modi buttressed by a solid parliamentary majority and a huge population of 1.4 billion people just reaching key income levels of roughly $2,200 per capita is setting the stage for that star turn.

The COVID-19 crisis, meanwhile, accelerated a digitalization trend already underway in India, with the ranks of the country's internet users surging by 400 million over the past five years, facilitated by the world's lowest consumer data charges, noted Anand Gupta, a Singapore-based investment director with Eastspring Investments (Singapore) Ltd.

That dramatic shift online has helped spawn a profusion of new business models across sectors, whether it's education technology, fintech, government services, consumer discretionary or direct-to-consumer, said Mr. Gupta, who oversees $1.5 billion in India-dedicated assets at Eastspring.

On March 17, Moody's Investors Service, citing the impact of surging oil prices, lowered its 2022 growth forecast for the Indian economy to 9.1% from 9.5%, but that still leaves the country with "the fastest-growing large economy in the world," Mr. Jayaraman noted.

By contrast, China is expected to grow 5.8% this year.

China is clearly the bigger economy, but through the magic of compounding, that gap in growth rates could make India a relatively attractive destination for investors, noted Praveen Jagwani, CEO of UTI International Singapore Pte. Ltd. UTI International has AUM of $4.1 billion, while Mumbai-based parent company UTI Asset Management oversees $170 billion.

In that sense, India's early stage of development — with a population roughly equal in size to China's but a $3 trillion economy between a fifth and a sixth of China's size — can be seen as a plus. "There's not too many other places where you could easily see a doubling of per capita GDP over the next seven years," noted Causeway's Mr. Jayaraman.

China will remain a very relevant market but its growth rate will taper to more developed world levels, whereas growth rates in India will remain quite high, given that they have another two decades of runway before Chinese and Indian per capita incomes are in the same ballpark, said Patrick T. Fisher, founder and managing partner of Creation Investments Capital Management LLC, a Chicago-based impact investment firm focused on financial inclusion in emerging markets. Creation Investments has AUM of roughly $2 billion.

When Creation launched 15 years ago, there were a number of interesting emerging markets but increasingly — and over the past three years in particular — India has "differentiated itself," Mr. Fisher said.

Todd McClone, a partner and emerging markets portfolio manager with Chicago-based William Blair & Co., said India has "got the demographics and it's at the part of the growth cycle where you get the inflection in growth — high enough that the amount and diversity of products and services people have enough money to spend on is really exploding."

If institutional investors begin ramping up their allocations to Indian equities over the remainder of the year, it would be a reversal of recent trends. According to data from Central Depository Services (India) Ltd., foreign investors trimmed their holdings of Indian equities by more than $15 billion over the first 10 weeks of 2022, a continuation of net sales during the second half of 2021.

Short-term factors — including the first rate hike in years by the U.S. Federal Reserve and the search for safe havens prompted by Russia's invasion of Ukraine — may be prevailing for now but all of the reasons for investors to come to India over the medium to long term remain intact, said Vivek Sharma, the Singapore-based head of the international institutional clients group at Edelweiss Wealth Management, the custody, clearing and execution business of Edelweiss Financial Services Ltd., Mumbai.

Despite that headwind, India's main benchmark indexes surged by more than 20% in 2021, as a growing number of local retail investors woke up to the charms of making regular investments — at a monthly average of $1.2 billion — in equity mutual funds through investment vehicles called systematic investment plans.

Last year marked the first time India's market has barreled higher in the face of consistent foreign selling, noted Mr. Gupta, who said he's seeing "massive interest" now among foreign institutional investors, presaging a reversal of those outflows. Likewise, Mr. Jagwani said he's seeing foreign investors actively looking for a good entry point once the global turmoil sparked by Russia's Feb. 24 invasion of Ukraine settles down.

Edelweiss' Mr. Sharma, meanwhile, said his firm is on track this year to sign up its highest number of new overseas money management clients for custody, clearing and execution services in years, a sign of strong underlying interest that leaves him confident net flows will be positive by the end of 2022.

If healthy economic fundamentals are driving interest in India now, analysts say events this year and last are providing a geopolitical tailwind as well, vis-a-vis China.

In many ways, India has been held to a higher standard than China over the years, with its messy democracy often compared unfavorably with its bigger neighbor's record of economic achievement, UTI's Mr. Jagwani said.

But in the shadow of the Russia-Ukraine conflict now, China is being lumped together with Russia, while India — even though it has maintained its ties with Russia — is getting some credit for aspects of its system that had been largely taken for granted in more placid times.

"On a relative basis, India gives you transparency, governance structures, independence of the central bank, independence of the judiciary and protection of minority shareholder rights, which is a far cry from what you'd get in China or in Russia," Mr. Jagwani said.

"India's a democracy," with laws that give an Amazon or a Procter & Gamble as much clout as any Indian corporate, said Eastspring's Mr. Gupta. "In today's world, that means a lot," he added.

Sashi Reddy, a Singapore-based portfolio manager with Stewart Investors, agreed, noting that for his team's approach of allocating capital with a 10-year time frame in mind, investing in "systems where there is accountability, where there's a recourse," is crucial. "Democracies provide that, albeit in a chaotic fashion," he said.

At the end of the day, "you're backing contract law if you're taking a 10-year view and the challenge with more autocratic systems is that things change overnight, the outcomes are binary," Mr. Reddy said. "When the going is good, the going is great. But when the tide turns, there's no place to hide," he said.

Consequently, "in our Asia-Pacific strategies, roughly 40% to 45% is invested into India, and just about 5% is invested in China" — a split pretty much the opposite of what the benchmark calls for, he said.

The Sustainable Funds Group at Stewart Investors that Mr. Reddy works with manages a combined $21.5 billion in Asia-Pacific, emerging markets and worldwide strategies.

In recent weeks, Chinese stocks were whipsawed by regulatory and geopolitical concerns, with the shares of some of the country's biggest companies plunging 10% a day on successive days before rebounding on signs of government support.

Jack Nelson, a Sydney-based portfolio manager with Stewart Investors, noted in an email that "investors are understandably nervous given the 100% loss of capital sustained by some in Russia" since the start of Russia's invasion of Ukraine and are likely "factoring in the non-zero probability of the fat tail risk that sanctions on China result in a similar outcome there."

For the past five years, China has been the focus of investor debates about carving out a dedicated, country-specific portfolio allocation but in light of this "Russia-Ukraine fiasco," there's likely to be more pushback now due to the need to discount the tail risk of Russia-style economic sanctions should, for example, China do something vis-a-vis Taiwan, said Causeway's Mr. Jayaraman.

Meanwhile, with India only about 12% of a global emerging markets portfolio, "if you think India has a great growth trajectory, by buying a GEM portfolio, you're not getting much of that," he said.

"That's why I could see investors adding a dedicated exposure to India on top of an emerging markets portfolio," Mr. Jayaraman said.