Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by JPMorgan Indian Investment Trust. 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.
JPMorgan Indian (JII) owns a portfolio of Indian equities, with a bias to quality and managers who prefer to take a long-term investment horizon. The trust aims to maximise capital growth by selecting companies with the potential to grow their earnings faster than the market over the long run. The managers, Rukhshad Shroff and Rajendra Nair, are willing to pay a premium for the best growth opportunities, so the trust tends to trade on a higher valuation than the index.
The approach is active, having an active share of 61% and zero weightings in some of the largest stocks in the benchmark, as well as zero weightings to sectors that the managers believe are less appealing. Over the long run this approach has paid off, with the trust outperforming the MSCI India index over five years in NAV total return terms. However, the managers’ active approach worked against them in 2017 and 2018, as two companies they do not own have led the market upwards.
Ruhkshad and Rajendra have been in charge of the portfolio since 2003, giving them extensive experience in this market. They can draw on the research of a broad team covering the emerging markets region, specialised by sector and working to a clearly defined research process aimed at identifying the best growth opportunities. As the above suggests, running the portfolio as actively as they do means that short-term returns may deviate from the market by a wide margin. The portfolio is relatively highly concentrated, with 62% held in the top ten positions, the highest proportion of the four closed-ended India funds. The portfolio also has the highest beta out of the three closed-ended finds that have a five-year track record, and the only beta above 1.
The managers have used gearing sparingly in the past, given the higher beta nature of the portfolio and the volatility that comes with investing in a single country. The trust aims for capital growth and does not pay a dividend.
The trust has traded on a persistent discount in recent years. Over five years, the average has been 12%, although in 2019 it has tightened somewhat to 9.7%. The board will hold a tender offer for up to 25% of the company’s shares at NAV less costs should the portfolio underperform the benchmark in the three years to September 2019. At the time of writing, the trust’s NAV has underperformed the MSCI India index by 12.9% since October 2016.
This is an attractive way to gain access to Indian equities over the long run, in our view. The strategy relies more on identifying strong companies and holding them for the long term than on trying to time the market with moves into different sectors and industries at different times. We believe this is more likely to have success over the long term, given how hard it is to time equity markets.
By the same token, we believe that trying to time an investment into and out of India is problematic, not least because unpredictable global or political forces can determine a single country’s equity returns. For instance, In India’s case the global oil price can be highly significant. An investor in this trust should therefore have a long-term time investment horizon.
|A portfolio geared to long-term trends in India||An active approach raises the possibility of underperformance as well as over performance
|An attractive discount, with clear potential for it to narrow should a tender offer be triggered
||The trust has been more volatile than the other Indian specialist investment trusts
|The managers have run the portfolio together since 2003, so are highly experienced in this market
||There is no dividend
As discussed in the previous tab, fund managers Rukhshad Shroff and Rajendra Nair, are willing to pay a premium for the best growth opportunities and the portfolio tends to trade on a higher valuation than the index. The portfolio’s forward P/E is currently 22.5 times, compared to 18.6 times for the MSCI India benchmark as of the end of May 2019. However, the expected return rate on the portfolio is substantially higher at 13.1% compared to 9.2% for the index (JPMorgan estimates).
Expected returns are calculated for more than 1,100 stocks covered by the emerging markets and Asia Pacific equities (EMAP) team, of which 103 stocks are Indian equities. The returns are derived from the forecast earnings growth and dividends, the expected change in valuation and the expected movement in currency. This is the same framework used across all funds run by the EMAP team, allowing comparisons to be made across the various countries. Forecasts are made over five years out, which is the minimum holding period Rukhshad and Rajendra expect to have when entering a position, although events can intervene.
Within that universe, they aim to identify those companies that are superior within three main categories: economics, duration and governance. These categories are used throughout JPMorgan’s emerging markets and Asia Pacific equities team (EMAP). By economics, the team means the performance of the business in terms of return on equity, cash generation balance, sheet strength and capital expenditure. Duration in this case is the timeframe of the opportunity, which depends on management mindset, the competitive position of the company in its industry, and its track record of innovation. Finally, governance means whether the company is run in the interests of minority shareholders, as well as the wider regulatory and political context.
Companies are then placed into one of three strategic classifications: premium, quality and trading. Premium companies are the highest quality and are expected to generate high returns long into the future (duration). Quality companies may be premium in terms of the strength of the underlying business, but the duration of the opportunity is expected to be shorter. Trading stocks are those that are not considered high quality, but offer short-term opportunities around changes in valuation or market leadership. The bulk of the portfolio is always in premium and quality stocks, with a smaller allocation to trading stocks, which gives a long-term tilt to quality versus the index.
A prime example of the premium category of stock is HDFC bank, the second-largest position in the trust at 9.2%. This stock is not in the MSCI India index due to the proportion of stock not traded. This company is a multi-decade story in the managers’ view. The bank is benefiting from the fact that, in the 1990s, India’s banking system was state-owned and sluggish, so upon liberalisation, private sector competitors were able to swiftly grow market share by offering superior service. HDFC has been benefiting from India’s demographic boom and increasing development, which means that more people need bank accounts and other financial products.
This is all supported by Prime Minister Narendra Modi’s reforms intended to bring India’s poor into the financial system. HDFC has compounded its earnings at 27% a year since 2007, but still only has a 6% market share. The bank is leading the way with the introduction of technology to the Indian market, as well as focusing on growing in rural areas as they develop economically. In the sector, JII also holds Axis bank, Kota Mahindra Banka and IndusInd bank, which together make up almost 23% of the portfolio. This contributes to the considerable overweight to financials, the highest overweight in the trust.
Stock concentration in the portfolio is relatively high, with 63% of the portfolio in the top ten holdings, the highest proportion of the four closed-ended India funds. The trust’s largest position, Housing Development Finance, represents 9.5% of NAV. This is a mortgage provider that is also benefiting from the financialisation boom in the Indian economy. On top of this, the trust has significant positions in insurers, including HDFC Life, the joint venture between HDFC and Standard Aberdeen.
The tendency to hold large off-benchmark positions and to have significant sector overweights and underweights has resulted in a high active share of 61%. In energy, the 13.5% underweight is mostly driven by a zero-weighting to Reliance Industries, worth almost 11% of the index, as well as the 10.4% underweight to the IT sector by not holding Infosys, worth 7.5% of the benchmark. The trust owns nothing in the more defensive utilities and communication services sector. It is also underweight the consumer staples sector, which is largely due to valuation grounds. Although quality and growth are the main focus of stock selection, extreme valuations are avoided. As a result, the managers don’t hold Hindustan Unilever, worth 3.5% of the index, despite believing that it is a quality business benefiting from India’s demographic growth and economic development.
For each of the companies the team covers, they complete a 98-question checklist covering the risks in the trust, designed to identify red flags in the three areas of concern: economics, duration and governance. This standardised checklist, made up of yes/no questions, allows comparisons to be made across sectors and geographies and brings an element of objectivity to what can sometimes be a subjective topic. Stocks held in the trading bucket are generally admitted with more red flags than those in the premium and quality buckets. Within the emerging markets region, stocks in the energy, materials and utilities sectors have the highest average number of red flags, partly thanks to state interference. This is one reason behind their low representation in this portfolio, which has a core of around 80% invested in high-quality companies for the long term. JPMorgan research shows that the companies with fewer red flags do significantly better and outperform the market.
excess return by risk profile quintile
The risks raised in this process are also helpful in guiding sustainable investing activities. JPMorgan is an active shareholder where it believes it can improve governance through engagement.
The company has the ability to use gearing, with the policy being to use shorter-term gearing for tactical purposes up to a maximum of 15% of NAV. The company currently has a £100m floating rate loan facility, of which none is drawn down. Fully drawn it would amount to roughly 12% of NAV. Having taken out the facility in 2016, it was in use until July 2018, when it was paid back. This shift in the gearing was fairly well timed, as the graph below shows.
net gearing vs performance
Over the past five years, the trust has significantly outperformed the index, returning 87.7% in NAV total return terms compared to gains of 77.2% for the index. The average Asia Pacific ex-Japan regional fund, judging by the Morningstar IT Asia Pacific ex-Japan sector, has made 72.9% over the period, showing an investment in India has outperformed over this time.
Over that period, the trust has the highest beta of the three India investment trusts that have a five-year track record, at 1.15. This has led to it displaying the highest volatility too, at 21.5%, which is unsurprising given the high levels of concentration in the top ten positions and the large exposure to financials.
In absolute and relative terms, the best years for the trust were 2014 and 2015. In May 2014 Narendra Modi was elected prime minister with a reformist, pro-market agenda. Global oil prices also collapsed, boosting the Indian economy given that it is a net importer. The two factors led to phenomenal returns for the market and trust in 2014, with JII outperforming thanks to being correctly positioned for a domestic cyclical recovery.
Starting in 2017 and continuing into 2018, the trust was hurt by the significant outperformance of Reliance Industries, which it does not own and makes up 10.5% of the index. Reliance is a conglomerate with its core activity being oil refining and distribution activities. In 2016 it launched a 4G broadband service as it sought to expand its footprint in telecommunications. This was well received by the market and the stock has more than doubled in local currency terms since the start of 2017. The trust also doesn’t hold Infosys, another significant outperformer and 7.5% of the index. In this case, Rukhshad and Rajendra prefer Tata Consultancy Services in the tech outsourcing sector. Both have done well – Tata outperformed since the start of 2017 – but not holding Infosys has led to an underweight to the sector, which has hurt the trust.
Over the past twelve months, the trust has struggled relative to the index thanks to these two underweights. However, Rukhshad and Rajendra are long-term stockpickers, and believe that their portfolio contains superior companies whose worth will lead to outperformance over the longer run.
one-year relative performance
The company aims for capital growth and does not pay a dividend. All expenses are charged to the income account, which is in deficit.
The trust has been managed by Rukhshad Shroff and Rajendra Nair continuously since 2003. The pair have therefore had over fifteen years managing this portfolio together. Rukhshad has 27 years’ experience in Indian equities. The pair draw on the research of the extensive emerging markets and Asia Pacific (EMAP) equities research team, which includes 30 analysts specialised by sectors. These analysts focus on the large and mid-cap end of the universe. They also have a dedicated analyst based with them in Hong Kong, Karan Sikkam, who focuses exclusively on Indian equities. In practice, this means he researches the smaller and mid-cap candidates for the portfolio, given that the large-cap universe is covered by the region-wide teams.
The trust has traded on a persistent discount in recent years. Over five years, the average has been 12%, although in 2019 it has tightened somewhat to 9.7%. This is considerably wider than peers in the Asia Pacific ex-Japan sector, reflecting the single-country risk.
The board has the authority to repurchase shares, but hasn’t used it since the start of the financial year in October 2018. However, the board has undertaken to hold a tender offer for up to 25% of the trust’s shares at NAV less costs should the portfolio underperform the benchmark in the three years to September 2019. At the time of writing, the trust has underperformed the MSCI India index by 12.9%, so a tender offer is a real possibility, in our view. We believe this should act as a discount-control mechanism over the next few months, and so would expect the discount to come in.
The ongoing charges figure is 1.09%, marginally cheaper than Aberdeen New India at 1.17%, Ashoka India at 1.2% and significantly cheaper than India Capital Growth fund, at 1.91%. The management fee is charged at 1% of assets less current liabilities (the trust has no long-term debt and has not done so for many years) up to £300m and 0.75% thereafter. There is no performance fee. The KID RIY is 1.59% compared to 1.4%, 1.28% and 1.91% for the three peers, although we would note that methodologies can vary.
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Fund History: JPMorgan Indian Investment Trust
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