India Holds Appeal For Long-Term Investors

Timothy McCarthy
June 13, 2014

Many American investors are afraid of investing in emerging markets, thinking it is too speculative. However, there are two important factors to consider:

-- As the developed world ages rapidly, it is important to invest in countries that have a younger demographic, especially if they are not borrowing as much as Europe, the U.S. and Japan.

-- There is now a group of more advanced emerging markets countries that reached a minimum critical mass in human infrastructure, market liquidity and regulation that can now warrant at least a small portion of your portfolio allocation.

Thus, mixing in such countries, even if it is only 10 percent to 15 percent of your total portfolio, over a period of years, and then letting it grow over the decades can actually decrease the overall risk while at the same time, increasing your long return.

India now warrants a portion of the minority allocation. Let us examine why, for instance, having 1 percent or 2 percent of your total equity portfolio dedicated to India and added over a period of years could be attractive.

Ever since the Congress Party (and in turn the United Progressive Alliance, or UPA) came to power in fiscal year 2004-05, they created a lost decade economically for India and erased part of the impressive gains of the previous 10 years. Stifling factors such as continued high levels of corruption, expensive populist schemes and a lack of institutional infrastructure improvement were mostly to blame. But the dramatic victory by the Bharatiya Janata Party-led National Democratic Alliance, led by the charismatic Narendra Modi, has given both global and local investors reason to consider putting India back on the "OK to long-term invest" list.

His platform and supporters from across the economic spectrum of India have committed to detailed and practical plans to de-bottleneck projects and favor economic growth over socialist ideals. This has led to the recent surge in the Indian stock market, or the so called "Modi rally," as foreign institutional investors alone poured nearly $8 billion into Indian equities.

However, like all markets, there will continue to be ups and downs. Foreign investment inflows are estimated to more than double to $60 billion over the next few years as overseas investors and companies as have confidence in the new government. The increased confidence of both international and domestic investors grew out of these pro-growth government reforms as well as the Modi government's parliamentary strength to now pass these reforms.

Modi's track record while he ran the state of Gujarat adds to that confidence. He developed and executed a strong institutional infrastructure and created an accountable bureaucracy to promote industrialization and privatization of key sectors like ports, water and power which he can now bring to the nation. Though critics will say that Gujarat was already better developed than the rest of India, Modi clearly steered it in a better direction while the UPA made a mess of the rest of India.

In particular, sectors such as financials, capital goods, auto, media, utilities and health care can provide a balanced exposure in an up-cycle as well as encourage domestic consumption growth.

Of course, all countries face a variety of uphill battles attempting to improve their economies. In the case of India, Modi's administration will have to curtail the cost of their massive energy subsidies and keep inflation at bay. However, the increase already seen in private sector planning for spending on CAPEX (or capital expenditures) and infrastructure growth should make these hurdles attainable.

Already, we have seen inflation decline from 11.2 percent in November of 2013 to 8.3 percent in March of 2014. And since Modi's successful election, the rupee has strengthened from 68 to about 60 to the dollar, and India's foreign currency reserves have also risen markedly.

Lest you think that India is not worth bothering with, it should be noted that its gross domestic product now ranks third in the world (based on a purchasing power parity basis), behind only the U.S. and China, is expected within eight years to have as many households with disposable income of $10,000 or more as the U.S. or the eurozone, according to research by The Royce Funds.

Many investors are concerned about global growth rates, especially in the developed world. Yet, according to Morgan Stanley's predictions, India is expected to grow at a rate in excess of 6.5 percent per year just over the next two years.

In looking at your overall global portfolio, there is also another reason to consider adding India into your mix of countries. China is now affecting not only East Asia's economies, but also other economies dependent on the export of commodities. As China and India are not highly correlated, having a piece of India in your portfolio gives an investor valuable global diversification.

Tim McCarthy is the author of "The Safe Investor," released in February 2014, and former chairman and CEO of Nikko Asset Management Co. He has also worked at other large financial institutions such as Fidelity Investments and Merrill Lynch.

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