Summary

• December saw Indian equity markets posting new lifetime highs, with the Nifty gaining nearly 3% and over 30% for 2017 (over 38% in US dollar terms). Small and mid-caps did even better with the Nifty midcap 50 index gaining over 6% in December and nearly 53% in 2017 (over 60% in US dollar).
• Markets were particularly buoyed by results from two state elections won by the BJP. The key election was PM Modi’s home state of Gujarat where he faced anti-incumbency pressure as well as some fallout from disruption caused by recent reforms (GST and demonetisation in particular). The BJP now control 19 of India’s 29 states.
• The Fund posted a strong positive return of 6.7% compared to the benchmark gaining 4.9%. Outperformance in November and December meant the Fund has recovered most of the underperformance versus the benchmark that we have seen over 2017.

Fund activity

The Fund had a quiet month, with two small additional purchases to existing positions. We used some stock weakness to add to both InterGlobe Aviation and State Bank of India. In addition we took part in a stock buyback of Infosys, which was conducted at levels considerably above the current market price. A number of stocks performed strongly over the last quarter of 2017, as well as a recovery in some sectors where the Fund is overweight. Our participation in a number of new listings has also worked well, with Godrej Agrovet, Dixons Technologies and Security and Intelligence Services all appreciating more than the market.

The Fund has retained large positions to a number of sectors that have up until recently not been rewarded by market price action. Export focused sectors such as IT and healthcare have been laggards over the year, and although we are underweight both we are optimistic that current valuations justify continued investment, albeit we are underweight both sectors. We have been significantly overweight capital goods and infrastructure related names, domestic sectors that have until recently also been an underperformers. The disruption caused by demonetisation and reforms such as GST as well as a tightening of standards in the real estate sector have all hit growth. We are now confident that the worst is behind us and are happy to retain our positive view.

Outlook

Much has been made about the impact that domestic liquidity has had on market returns. Data for 2017 showed that foreign investors allocated US$7.4bn to India, the highest since 2014 although well below levels we have previously seen. A record US$12bn was invested by domestic institutional investors, a trend we see continuing. Despite this liquidity India did not outperform other emerging markets, despite pushing through with ground-breaking reforms that set the country up well for the future.

One reason foreign investors didn’t allocate more to India is valuations. Some sectors are undoubtedly trading at eye-watering levels, particularly fast-moving consumer goods. We remain underweight here as we believe the market leadership will rotate to more economically sensitive sectors as confidence in the economic recovery gathers pace over 2018. Manufacturing data continues to improve and the ongoing push by government on infrastructure and housing investment will boost growth and employment. In addition the continued robust global economy will help exports, and attract further inward investment from global corporations into India. We think that better growth will finally lead to a more consistent earnings outlook for India.

Politically there are a number of state elections in 2018 that will be an important indicator of sentiment as we approach the national election expected sometime in the first half of 2019. For this reason, we expect government to be focused on implementation and growth, rather than further reform. For that we will have to wait and see how Modi does in 2019.