Aberdeen New India

ANII’s quality characteristics could stand it in good stead in a weak economic period…

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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by Aberdeen New India. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Aberdeen New India

Summary

Aberdeen New India Investment Trust (ANII) owns a portfolio of Indian companies chosen for their strong balance sheets, sustainable earnings and good governance, factors which should make them resilient to weak economic conditions as well as making them able to grow faster than the market over the long term.

ANII has a strong long-term track record of outperformance which has been boosted by good performance in weak markets, although relative performance has been weaker in the past five years. In 2020 the portfolio outperformed in the initial coronavirus crash despite being geared going in, although it has lagged in the recovery, meaning ANII is behind the index year to date – as we discuss in the Performance section.

The portfolio is managed by Kristy Fong and James Thom. They draw on the detailed stock-specific analysis of the Aberdeen Standard Asian equities team. The team view strong corporate governance as an important characteristic of a quality company (see the ESG section), and it is a key issue determining whether they invest or not. Kristy and James believe that giving up these principles for short-term gain could lead to worse losses in the future.

Kristy and James have taken advantage of the volatility in the current crisis to invest in companies at more attractive valuations. They have focussed on building more resilience into the portfolio, believing that the short-term economic outlook is cloudy. Among the new stocks they have bought is Info Edge, a group of e-businesses benefitting from the structural shift online.

Discounts on the India specialist trusts have widened during the pandemic, and ANII’s shares are currently trading 16.6% below NAV.

Kepler View

India is an exciting long-term prospect. The country’s demographics mean there are huge long-term growth opportunities in goods and services serving a growing young population. ANII has many high-quality companies which are plugged into this growth, such as financials offering financial products to those who have never had them before and companies developing e-commerce in this underpenetrated country. The country could also benefit from the cooling of US and European attitudes to China, as companies look to relocate manufacturing away from China.

However, the short-term outlook is less clear, and we think economies could be about to experience a hangover after the various government support programmes roll off and the full impact of the lockdown becomes clear. In the meantime, ANII does have exposure to businesses which are major beneficiaries from the shift to homeworking and shopping, including IT and e-commerce.

At the moment ANII is cheap, and on a wide discount relative to its history and emerging markets trusts. Investors could wait and try to time the bottom, but this is notoriously difficult. As such, we think this could be an interesting long-term entry point, although near-term investors in all equity markets could be in for a difficult time. We think ANII’s portfolio is more suited to a tough economic environment than most, and the focus on quality characteristics could see it outperform.

bull bear
Strong long-term record based on successful stock-picking Gearing can magnify market falls as well as losses
Quality approach has provided resilience in weaker markets As a single-country emerging markets fund, it has political risk
Discount is wide and could be an interesting long-term entry point Continued outperformance of Reliance Industries (not held) would be a relative headwind

Portfolio

Aberdeen New India Investment Trust (ANII) aims to generate long-term total returns from a portfolio of Indian equities chosen for their strong balance sheets, sustainability of earnings and good governance. ANII is managed by Kristy Fong and James Thom, who implement the bottom-up approach of the Aberdeen Standard Asian equities team which has led to long-term outperformance in the Indian market. The managers aim to identify the leading companies in their sectors or industries, invest at attractive valuations and hold for the long run.

As we discuss in the Performance section, this approach has generally led to outperformance in falling markets. In 2020 the quality characteristics again saw the portfolio perform slightly better in the crash despite it being geared. However, it has failed to keep pace in the sharp recovery since March. However, Kristy and James are maintaining their focus on defensive qualities, and they are concerned that the macroeconomic picture for India and the wider region in the second half of the year is not as good as the giddy stock markets would suggest. They have been taking the opportunity to buy companies whose valuations have taken a knock, while reducing their exposure to the most COVID-sensitive areas (exiting their only hotel stock, for example).

Although they have responded to the crisis with a flurry of activity, the strategy and approach have not changed. A focus on quality means identifying companies with high and sustainable returns on equity and strong balance sheets. This means those which have the ability to persistently generate higher-than-average returns over the long run, through good times and bad. Low levels of debt are considered desirable as this factor, coupled with high free cash flow, gives flexibility to cope with weak economic periods and to invest in future growth.

Kristy and James also consider corporate governance to be a vital element of a quality company. As we discuss in the ESG section, this is embedded in the research process of the analysts and considered at every stage. Meeting company management is a crucial part of this assessment too, and generally speaking the managers are cautious with making new investments, preferring to take their time and wait for the right valuation rather than rushing in. Although valuation is important, particularly with regard to entry points, this is always considered relative to the growth prospects of a business and the managers are willing to pay a higher valuation for a higher-quality business. This comes through in a historical trend for ANII’s portfolio to be more richly valued than the market.

Sector exposures are derivative of stock selection. That said, they do reflect where the managers see the best prospects for sustainable growth as well as for the best-run companies. For example, financials has long been an area of concentration. ANII has made good money by investing in the best-run private sector banks, which have steadily been increasing their market share at the expense of the cumbersome state-owned banks ever since the 1990s reforms which birthed them. This is a trend which has a long way to run, the managers believe.

India has been suffering a banking crisis which began with the default of IF&LS in 2018. In Q1 2020 Yes Bank, which had exposure to IF&LS and Dewan Housing (which defaulted late last year), was taken into administration. Kristy and James think this is supporting a trend towards consolidation as the stronger operators prosper at the expense of the weaker. Non-banking financial companies are finding it harder to get funding thanks to risk aversion from lenders given the ongoing crisis, while the public sector banks are inefficient. This leaves the stronger private sector banks, such as ANII’s holdings Kotak Mahindra Bank and HDFC Bank, in an even stronger position. ANII’s stock selection in the financials sector has been positive this year, as Kotak Mahindra Bank and Housing Development Finance Corporation have done well.

Below are the top ten positions in a highly concentrated portfolio, with about 55% in the largest ten positions and 69% in the largest 20. Although the MSCI India Index is also concentrated, with 56% in the largest ten positions, ANII’s top ten looks very different. For example, the largest company in the index is Reliance Industries, which makes up 15% of the benchmark and is not held by the trust.

top ten holdings

holding
weight (%)
Housing Development Finance Corporation
8.8
Infosys
8.5
Tata Consultancy Services
8.0
Hindustan Unilever
6.2
Kotak Mahindra Bank
4.9
SBI Life Insurance
4.1
ITC
4.0
UltraTech Cement
3.8
Nestlé
3.5
Mphasis
3.5
TOTAL
55.3

Source: Aberdeen Standard

Another key area of conviction is the IT sector. Here both Infosys and Tata Consultancy Services are significant positions. Like information technology stocks worldwide, they have proven more resilient to the lockdowns and working-from-home edicts pronounced by governments such as India’s. Both companies are benefitting from their clients’ increasing use of digital and cloud services. The predominantly overseas earnings from these outsourcing giants have also been a huge help as the rupee has devalued against the dollar this year. Financials and information technology are both overweights, as the below chart indicates. Another key area of conviction is consumer staples, where companies benefit from visible earnings growth potential in the light of India’s young population and its stage of economic development.

sector allocation

Source: Aberdeen Standard

One exciting new holding in a technology-related field is Info Edge, although this sits within the communication services sector. Info Edge is one of the new additions Kristy and James have made after the coronavirus sell-off led to more attractive valuations. Its core business is online recruitment, where it has a strong leadership position. This business generates healthy cash flows which have allowed it to branch out into other areas of e-commerce, such as food delivery and insurance. Kristy and James have admired the stock for some time but have not been comfortable with the valuation. In their view the company is well run by its founder and has a highly profitable core business.

As we note above, ANII does not own Reliance Industries (responsible for the underweight to oil & gas). This is a conglomerate and the largest stock on the Sensex Index. It has branched out from its original fossil fuels business into e-commerce through its subsidiary Reliance Jio. Reliance Jio has launched a new mobile-phone network and also generates online content. Reliance Industries has outperformed the market strongly since embarking on this transformation, and so not holding it has hurt relative returns for ANII. However, Kristy and James have long been held back from investing by corporate governance concerns and the group’s capital allocation track record. Whilst they recognise that the group has been making progress in deleveraging its balance sheet, and that prospects of the group’s e-commerce-based ventures look attractive, they think the market appears to be paying for future growth in which execution has yet to be proven.

This decision illustrates two crucial features of the investment process well. Firstly, the high-conviction nature of the portfolio – the managers have not taken exposure in order to profit from momentum, but have stuck to their views on the fundamentals. Secondly, the patient approach means that they are not rushed into a stock but wait for attractive valuations and credible evidence of the sustainability of earnings. In fact, stock selection is a cautious, painstaking process which involves detailed fundamental analysis of each candidate company’s financial track record. The analysts/portfolio managers on the Asian equities team insist on meeting management before investing, in order to assess the quality of corporate governance at each company.

This cautious approach continues once invested: the managers tend to invest a small position and raise this stake steadily as their conviction increases and they become more familiar with a company. A crucial element of the investment process is that once invested, Aberdeen Standard is highly active as a shareholder, looking to encourage improvements in corporate governance which should improve the sustainability of the business’s profits and cash flows over the long run. As the team aim to be long-term shareholders, sustainability is particularly important to them.

Over the past three years the turnover in the portfolio has averaged just 14% according to Morningstar data, although we expect it may be a bit higher in 2020 given the activity prompted by the volatile markets. As well as the purchases discussed above, this activity includes taking up a new position in Crompton Greaves Consumer Electricals, a supplier of fans, heaters, pumps and related products. Another new position is Varun Beverages, a bottler which is PepsiCo’s largest franchisee outside the USA. Power Grid Corporation of India and Fortis Healthcare, India’s second-largest hospital chain, are the other new additions. Kristy and James have also added to their existing holding in Syngene This company acts as a research outsourcer for the pharmaceutical industry, so it does not take the risks of failed drugs but benefits from increased research and healthcare provision.

Gearing

The board of ANII has given the managers discretion to alter gearing levels within the framework the board sets. ANII can gear up to 25% of NAV at the time of investment, but is limited by the facility the board arranged in 2018: a £30m multicurrency revolving credit facility. This amounts to 10% of NAV (c. £297m). Kristy and James take a cautious attitude to gearing, and aim to be opportunistic. They have therefore drawn down tranches of the facility after market sell-offs, such as those which occurred in the fourth quarter of 2018. After the February/March sell-off this year they also used the facility to invest in a few names, but have already locked in some profits after the rebound and reduced gearing by trimming or selling some exposure. Kristy tells us the board is open to the idea of raising the gearing levels, but it views 10% as a reasonable limit. At the end of July net gearing was 6.1%, with borrowings offset by 2% cash. There is therefore limited scope to increase the gearing in the near future, and we understand the managers are comfortable with the current level.

Returns

ANII has more than doubled the returns of its benchmark (the MSCI India) over ten years, generating NAV total returns of 108% compared to 49% for the index. However, this outperformance came in the first half of that period and ANII has slightly underperformed over the past five years, thanks largely to its 2020 returns so far. Although the NAV held up slightly better than the Indian market in the crash, the portfolio has been slower to recover. Over five years NAV total returns are now 52.1%, compared to the 56.1% total returns from the iShares MSCI India ETF which tracks the trust’s benchmark. ANII has generated these returns with less volatility than that seen by the index and peers, and with a beta of 0.9.

five-year performance

Source: Morningstar

Generally speaking, ANII has done better in falling markets. The five-year upside/downside capture ratio is just over 1, with the portfolio capturing 90.5% of upwards movements in rising markets and 90% of downwards movements in falling markets. This number has dropped since our last report in February thanks to the impact of the coronavirus crash, when markets fell together in a highly correlated way. However, the below chart indicates that out of the last three years in which the Indian market has ended down, ANII has beaten the market and generated positive NAV total returns in two of these years. In fact, ANII outperformed the ETF in each of the six years to 2018 inclusive.

returns

Source: Morningstar

The difference this time, so far, has been the stunning outperformance of technology stocks in the rebound. While technology stocks are certainly benefitting from changes to living and working practices during the pandemic, in our view the market is in danger of getting ahead of itself. Kristy believes that the economic impact of the lockdowns and a possible resurgence of the virus in the winter could lead to a difficult end to 2020 for India and the region as a whole. If this does spark a sell-off, in our view the stocks which have run up the most could be the most vulnerable.

As discussed in the Portfolio section, ANII does have exposure to the internet and e-commerce. It does not hold Reliance Industries, however, which is the largest company on the Indian market and has outperformed thanks to investor reception of its move into the provision of mobile-phone networks and online content. This year Google and Facebook took significant stakes in its online platform Jio Platforms. As discussed above, the company is now trading on a high valuation and the team prefer Info Edge in this space.

As the below graph illustrates, ANII actually outperformed the index slightly in the correction this spring, which is impressive given its structural gearing and is a testament to the defensiveness in the quality portfolio Kristy and James have built. This defensiveness could be critical if the managers’ bearishness on the immediate outlook for the Indian economy is justified.

one-year absolute and relative performance

Source: Morningstar

Dividend

The trust is managed for capital growth and has not paid a dividend since 2005. Income is used to pay expenses and is offset by past tax losses.

Management

The trust is run by the Aberdeen Standard Asian equities team who are based in Singapore. They take a team-based approach which means they aim to build consensus on their stock picks across the region. However, there are two team members with special responsibility for this portfolio: Kristy Fong and James Thom. Kristy and James are the key decision-makers regarding buys and sells and the day-to-day management of the portfolio. The Asian equities team are led by Flavia Cheong from Singapore, with her deputy Kwok Chern-Yeh being based in Tokyo. The team share a common investment framework across their single-country and regional portfolios. This framework seeks to identify high-quality companies which have sustainable earnings streams, and places great importance on corporate governance and engaging with companies to improve how they treat minority shareholders.

Discount

ANII’s shares trade on a 16.6% discount to NAV, wider than the 12.3% average of the AIC Global Emerging Markets sector and ANII’s 12.7% five-year average. The current discount is very close to that of the trust’s closest competitor JPMorgan Indian Investment Trust (17.4%), and wider than that of Ashoka India Equity Investment Trust (3.5%). The mid-cap specialist India Capital Growth Fund is on a 21% discount. The Indian trusts have fallen out of favour in the aftermath of the coronavirus crash. Partly this is because China began its recovery more quickly and took the flows, and partly this is due to India being seen as handling the virus badly, hence why ANII’s discount has drifted wider even as markets have recovered.

discount

Source: Morningstar

The board has the authority to buy back shares to control the discount, and has committed to doing so when it believes this would be in the best interest of shareholders (while paying regard to the overall size of the trust’s portfolio). In recent years the board had preferred to rely on performance and marketing to close the discount. However, since August 2019 it has been conducting regular buybacks. The 2020 financial year (which ended in March) saw c. 350,000 shares bought back at a total cost of £1.6m. This compares to a market cap of c. £245m. There is also an annual continuation vote which has been held each year since 2005.

Charges

ANII’s last published OCF is 1.17%, which compares to a simple average of the four India specialist trusts of 1.13%. The management fee is 0.9% on the first £350m of net assets. Net assets are currently £329m, but when they rise above £350m they will be charged at 0.75%. There is no performance fee. The KID RIY is 1.39%, which compares to a weighted average of 1.63% for the Indian trusts, although calculation methodologies can vary.

ESG

The Asian equities team at Aberdeen Standard believe ESG and sustainability issues are intrinsically linked to the ‘quality’ of a company, and that sustainability in the broader sense is important for the sustainability of a company’s earnings. In the past, Aberdeen Standard (and Aberdeen Asset Management, long before the 2017 merger) was a standard bearer when it came to corporate governance. It has always placed great importance on the incentives and attitudes of management to minority shareholders. In recent years, the Aberdeen Standard Asian equities team have integrated environmental and social issues more into their assessments. Team members generate their own ESG ratings for candidate stocks and also consider the ratings of external providers in order to understand the difference. Once invested, the team view themselves as long-term partners of management, and encourage companies to improve their behaviour vis-à-vis shareholders and stakeholders more widely.

As an additional resource, the team are also able to receive inputs from Aberdeen Standard analysts based in Edinburgh who consider top-down global issues such as plastic use and climate change. There are also three dedicated ESG analysts sitting within the team in Singapore who cover the Asian region, and their task is to consider what progress is possible and desirable within the regional context.

Fund History

Disclaimer

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