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Craig Farley and Simon Finch

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No more Bull for China while Modi wins historic India state elections

20 Dec 2017
When BRIC funds were in vogue, Ashburton Investments took the bold decision to do something a little bit different; selecting China and India only, we created a fund focused on the long-term outsized potential of these two great nations.

11 years later and the countries still offer strong growth profiles, relative stability and clear reform mandates. However, 2017 has also shown just how different they are. This reinforces the need for our blended investment approach that has delivered strong returns in two of the world’s most significant economies. Fund Managers Craig Farley and Simon Finch look at recent events and action taken in the Fund to capture the key drivers for the future as we head into the New Year.

China – No more Bull

The rally that has taken place over the past twelve months has further cemented the sharp shifts in sentiment that underpin China’s equity markets.

Currency devaluation, a “hard landing” or the bursting of China’s credit bubble were near the top of potential global risks for many investors going into 2017. Positive year to date returns of 21.9% and 52.0% for the Shanghai Shenzhen CSI 300 Index (onshore China) and MSCI China Index (offshore China) respectively, highlight the uncanny ability of equity markets to confound consensus thinking.

The Ashburton Chindia Equity Fund has been positioned to capture the lion’s share of these gains. The Fund does not rely on economic data or forecasting in its decision-making framework to allocate capital and manage risk in China. Instead, the assessment of underlying market conditions is done by looking at the internal dynamics of the equity market and establishing prospects for healthy returns.

Whether China’s market internals are ‘bullish’ (‘buy’) or ‘bearish’ (‘sell’) motivates the country skew in the Fund within current maximum/minimum country thresholds of 60%/40%.

China’s internals have been leaning bullish all year following a ‘buy’ signal generated on 11 January 2017. This has been reflected in a significant overweight allocation to China, funded by a significant underweight allocation to India. Chinese exposure has been skewed towards cyclical, high beta sectors (notably auto, material and real estate stocks), generating significant performance at the stock level. However, of late, market action has begun to waver and we have witnessed a sharp deterioration in our models, culminating in a ‘sell’ signal on 6 December.

The model is not a crystal ball but seeks to provide timely buy and sell signals through market cycles. Currently, the model suggests China’s short-term equity market prospects are far less attractive than they have been recently. Ashburton have utilised a fully systematic and quantitative approach in our investment process and philosophy to China since 2014, with award winning results. The rationale is simple: to instil clarity, discipline and objectivity into our decision-making framework. In light of the recent ’bearish’ signal, the Fund has reduced China to a significant underweight country allocation through a combination of equity sales and put options. 

While China adjusts after its bullish year, India is now looking forward to a brighter future following some short-term, self-inflicted pain in 2017.

India - Prime Minister Modi’s party creates history

For the first time since Independence in 1947, one party now controls 19 of the 29 Indian states: Prime Minister Narendra Modi’s Bharat Janata Party (BJP).

Election results in the northern Indian state of Himachal Pradesh, as well as Modi’s “home” state, Gujarat, went better than expected. In Gujarat, the BJP was facing huge anti-incumbency pressure having been in power for five terms. The BJP were challenged by the Congress Party led by Rahul Gandhi who was only recently appointed as the party’s president. Although the BJP secured an outright majority, winning more than 54% of the seats, the margin of victory was perhaps not quite as strong as hoped. Factors such as the anti-incumbency feelings, as well as a recent pick up in food price inflation may have tipped some votes towards the more rurally appreciated Congress Party.

In Himachal Pradesh, the BJP ousted the Congress Party, winning two-thirds of the seats and nearly 50% of the votes. To gain another state, taking the party into new territory bodes well for 2018 and the run in to the 2019 general election. Modi’s saffron coloured party colours are continuing their spread across the map of India, lifting sentiment across the capital markets, given Modi’s taste for taking bold decisions.

The Sensex Index was initially down more than 800 points with early results suggesting the BJP may in fact lose the Gujarat election. However the market rallied strongly once it became clear that Modi’s reform agenda would once again deliver a winning outcome for his party.

Interestingly, the “None Of The Above” vote secured nearly 2% of the share in the Gujarat election and would have ranked fourth if it constituted as a party. This can be read as a protest vote; a weak opposition Congress Party, negative sentiment with regards employment and anti-incumbency pressure. 

Modi is aware that there are pockets of unrest, particularly the farming communities that have historically been the bedrock of the voter base for the Congress Party. They will no doubt become more vocal as we move towards the general election and we expect further more populist announcements in the coming months. We have already had farm loan waivers across a number of states, while a bill has been raised in Parliament for an additional US$5bn allocated to a rural employment scheme. 

Job creation, housing availability and rising food price inflation will be critical issues for Modi to address in the early stages of 2018. It is widely expected that the Union Budget will deliver further reforms and additional measures to ensure the BJP gains greater control of the Upper House to push onwards with its plans for India. Ultimately the BJP have achieved two state election victories on its road to re-election in 2019 and we can expect Modi to tackle areas of weakness in the coming months. This is why we remain positive on Indian equities into the New Year.

Chindia in 2018

Entering the Fund’s twelfth year, the world’s two most populous nations continue to push forward with reform. With largest democratically-elected and socialist governments respectively, India and China are moving into the New Year with very different, yet continued optimism that is captured by Ashburton Investments’ unique approach to investing in these markets.