The current environment and the impact of COVID-19 - Indian Subcontinent Sustainability Fund
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- The current environment and the impact of COVID-19 - Indian Subcontinent Sustainability Fund
As of the day of writing this article, India is in the midst of a three week lockdown while Bangladesh and Sri Lanka have temporarily shut their stock markets. The subcontinent’s infection rate seems suspiciously low and limited testing could be a key reason. Meanwhile, the region is facing a monumental challenge in restricting movements of migratory labour while daily wages are lost. One hopes the measures taken are the right ones especially in light of the poor healthcare infrastructure in the region. In this context, the subcontinent feels particularly vulnerable should COVID -19 infections rise quickly.
At this point there are as many questions as there are answers regards COVID-19. Let us first acknowledge that this is unlike any other crisis we have witnessed in our lifetimes.
Have we been here before?
Yes and No. As investors we have seen many market corrections in the past. But no living portfolio manager has been witness to a pandemic. The last time the global wheels stopped turning completely like it has today was during the world wars and the Spanish Flu. Being aware of long term history and reliving experiences from epidemics like SARS helps. Equally, predicting the extent of economic damage and change in behaviour after such a crisis will be challenging. We are debating the myriad of possibilities that await us post this crisis and the likelihood of having to change our views completely on long-term headwinds or tailwinds for many companies.
Steep market corrections are not new to the region. But none of these were followed by prolonged economic slowdowns. Only on three occasions, since the 1991 liberalisation of the economy, has India’s growth faltered below 4%1. Economic growth in all these instances quickly recovered to higher levels once capital flows reversed.
It is certain the impact this time on the real economy will be more acute short term. What is also true is that governments globally are acting quickly and prepared to use any fiscal and monetary tool in their armour to revive their respective economies. The speed and scale of this response is unlike any other crisis in history. It remains to be seen when and in what form economies globally recover back to some semblance of normality.
How is the portfolio positioned?
Year to date to 31 March, the Fund was down 20.4% (GBP – Class A shares) and down 20.3% (GBP – Class B shares). The Fund was down 25.4% in USD (Class B shares). In comparison, the MSCI India Index has fallen 26.4% in GBP and 31.1% in USD2.
The portfolio is currently invested 74% in India, 10% in Bangladesh, 3% in Sri Lanka and the remainder in cash3.
As we have highlighted many times in the past, a quality private sector has had a much larger role to play in the development of the subcontinent. This is certainly not the first time many of these companies have faced adversity. Companies with long-term horizons, safe balance sheets and an ability to invest counter cyclically will be able to withstand and emerge stronger from this crisis. Most of our companies barring banks have a net cash balance sheet.
The portfolio has investments in seven financial services companies, comprising around 18% of the portfolio. The main investments are in HDFC, Kotak Mahindra Bank, Delta Brac Housing and Sundaram Finance. These institutions have a history of building their businesses through many crises by strictly adhering to conservative lending practices. This has helped them build trust with their lenders and depositors further strengthening their franchise and improving access to affordable capital. The subcontinent still has a long way to go to achieving meaningful financial inclusion in the broader community. However, we are watchful of the risks of prolonged national service during such times.
The Mahindra Group was tackling a cyclical slowdown prior to the arrival of COVID-19. Transitioning to a net cash balance sheet for the first time in decades, they set themselves up to emerge stronger. But this recovery will now be delayed further. Elgi Equipments is the largest maker of compressors in India. In the last decade the group embarked on a journey to become a leading player globally in the compressor market. They have had to take some debt to fund these aspirations. This journey will be met with a few more obstacles in the short term. While both of these companies have had a negative impact on the portfolio we remain positive on the overall quality of their long-term investment case.
Hindsight in such circumstances can be useful and dangerous. Any purchases made across our strategies in the last year look poor and any sales looks heroic. Where we wish we had acted a bit differently is position sizes in some cyclical businesses.
Is it all doom and gloom?
No. We are more excited now than we were in the last decade. We have been advocating high valuations as a risk for a while. That phase is certainly behind us now. We feel the coming year might start providing attractive opportunities for investors to allocate capital to this region.
A few reasons why we continue to believe the next decade will deliver sound absolute returns.
• A long list of high quality private companies operating in the subcontinent
• Most basic goods and services are still quite underpenetrated
• The crisis should provide exciting opportunities for well stewarded companies
• Sustained low oil prices could be helpful for the region
• Governments could face less resistance to fast track important long pending reforms
• Interest rates have room to come down significantly in India
• The subcontinent could benefit from any diversification of global supply chains
We constantly remind ourselves that it is easier to be bullish at the top and bearish at the bottom. We have a list of quality companies whose valuations were too expensive for the portfolio for many years. Given the pace of this correction, many of these companies might become attractively valued for us sooner than later.
We are mindful of worst case scenarios and the failure of society to find a quick solution to COVID-19. But with technological advancements and a more coordinated global effort, we hope the human race stands a much better chance this time than it did with the Spanish Flu.
1 April 2020
Absolute return – a return provided by a share or portfolio which is not measured relative to another share or benchmark index.
Cyclical – Companies that operate in industries which are sensitive to movements of the economy.
Counter cyclical – Companies that typically do better during economic downturns.
Gross Domestic Product (GDP) – the monetary value of all the finished goods and services produced within a country’s borders in a specific time.
Net cash – a company’s total cash minus total liabilities when discussing financial statements.
GBP - Class A shares
GBP - Class B shares
USD - Class B shares
These figures refer to the past. Past performance is not a reliable indicator of future results. For investors based in countries with currencies other than those shown, the return may increase or decrease as a result of currency fluctuations.
Source for fund: Lipper IM/Stewart Investors. Performance data is calculated on a net basis by deducting fees incurred at fund level (e.g. the management and administration fee) and other costs charged to the fund (e.g. transaction and custody costs), save that it does not take account of initial charges or switching fees (if any). Income reinvested is included on a net of tax basis. Source for benchmark: FactSet, income reinvested net of tax. Since launch performance calculated from 15 November 2006 for the GBP Class A shares, from 9 November 2012 for the GBP Class B shares and 8 December 2014 for the USD Class B shares.