Paul O'Connor:

Welcome to the Netwealth Portfolio Construction podcast series. I'm Paul O'Connor and I'm head of investments. That includes responsibility for the funds available on our investment menus and the products we issue as a responsible entity, namely being the GSS funds and the managed accounts. Joining us on today's podcast is Mugunthan Siva, or Mugs, who's managing director and co-founder of India Avenue Investment Management. India Avenue is a business focused on India as an investment destination for clients seeking to benefit from India's multi-decade economic growth story. Mugs is responsible for the firm's investment philosophy and process as the firm's chief investment officer and asset growth as the firm's managing director for its two long-only equity funds. He has a significant role in the firm's governance framework as acting chair of the India Avenue board and chair of the investment committee. Mugs acts as a senior mentor to the investment team whilst being responsible for all aspects of investment performance and governance in the decision-making process.

Mugs has spent over three years based in Mumbai as part of start-up team building an asset and wealth management division for ING Investment Management India in the role as chief investment officer. He's now based in Sydney and has spent most of his 32 working years in Australia's financial services industry across research and portfolio management roles in financial planning, stockbroking and superannuation funds. Prior to co-founding India revenue, Mugs was head of portfolio management for ANZ Wealth and he has also worked for Westpac, Macquarie, ING and RetireInvest in prior roles. Mugs holds a masters of business from UTS, a grad diploma from FINSIA, and a bachelor of commerce from the University of New South Wales. The India Avenue equity fund is available on the Netwealth super and IDPS investment menus. The fund employs a multi-manager strategy that's actively managed long-only, all-cap product that invests predominantly in listed Indian companies or companies on other exchanges with a significant exposure to the Indian economy.

The fund is diversified across investment styles, but over the long term is expected to have a growth bias. Australian investors have historically allocated to emerging markets as a growth allocation in a broader global equities exposure and Australian-issued emerging market funds typically have a bias to Asian and Chinese equities, hence the exposure to Indian equities is typically only a very small allocation within a diversified emerging market product. The Indian equities market's dominated by a small number of mega-cap stocks that emerging market and international equity funds have invested in. But what about the rest of the Indian equities market? The top 10 stocks in the MSCI Indian Equities Index make up about 35% of the index by market cap. So what other opportunities exist for investors in the world's most populated country? I'll ask Mugs to elaborate on this during today's podcast. The Indian economy is the fastest growing major economy in the world that has generated strong GDP growth of over 8% per annum for the last three years, and prospects appear sound for this to continue in the years ahead.

In addition, India is a democratic country with a sound rule of law so I'm surprised more investors are not making discreet allocations to Indian equities. As highlighted in a recent Deloitte report, there were prevalent signs of the rural Indian economy rebounding with strong growth in manufacturing, robust bank balance sheets and credit growth and stronger exports in services and high-value manufacturing. So there's confidence that India's underlying potential will help it outpace growth in the rest of the world in the coming years. With an increasing probability that the global economy is anticipated to rebound in 2025 as major election uncertainties are resolved and western central banks possibly implement rate cuts as inflation concerns subside, India's likely to experience improved capital flows, boosting private investment and exports. These factors should continue to support the Indian equities market. Mugs, can we start maybe by asking you a few comments about your career journey and what led you to establishing India Avenue?

Mugunthan Siva:

Sure, Paul. When I was working with ING in my time over in Mumbai, I had been bitten by the India bug as such. At that time, it became evident that India at one stage would become the world's leading growth economy. I suppose the underlying fundamentals and the demographics of a very large population, which is the most populous now with a young average age of 29, would eventually have lots of working age people, which would lead it to be very productive and therefore solid corporate earnings growth would be generated, which would be great for equity market conditions.

Paul O'Connor:

So given my opening comments on the Indian economic GDP growth, what is the trajectory compared to the rest of the world?

Mugunthan Siva:

Well, if you look at India's GDP growth over the last, let's call it 20 years post turn of the century, its average is about 6.5% real GDP growth. Going forward, when you perhaps look at the IMF, they're forecasting India to retain that growth rate of about 6.5 To 7%.

Paul O'Connor:

And is GDP growth actually feeding through to increase corporate earnings?

Mugunthan Siva:

This is one of the critical questions when investing in emerging market countries is the high anticipated growth rate necessarily feeding into corporate earnings and equity market returns. So we can say in a country like India, there has been a reasonable correlation between nominal GDP growth and corporate earnings growth, which has led to equity market return. So it is one of those markets where having high GDP growth has translated into fairly robust equity returns.

Paul O'Connor:

The MSCI Indian Equities Index has generated returns in excess of 15% per annum for the last five years. So can you comment on whether the earnings multiples are being supported by corporate earnings?

Mugunthan Siva:

Yeah. Pre-COVID, we saw India's GDP growth slowing largely because there was a lot of reforms implemented when the Modi government came into power in 2014 and there was some indigestion in some of those reforms, and therefore India's GDP growth slowed to about 3 to 3.5%, which is quite weak for an economy like that that needs a lot of growth. In that period, corporate earnings also slowed. The pandemic, however, led to some initiatives being adopted, some reforms being taken on, some changes being made, which led to a pivot towards an understanding that growth was going to be the saviour. And post that, we've seen GDP growth accelerate and corporate earnings growth accelerate really for the last four to five years.

Paul O'Connor:

We've certainly experienced the rise of inflation in the developed world over the last, I guess three years post-COVID, but is inflation a cause for concern in the Indian economy and is Indian monetary policy currently accommodative or contractionary?

Mugunthan Siva:

Yeah. Good question. India's inflation over the last 20 years would've averaged close to 7%. And why is that? The basket as such for CPI has a high component of food and energy, which is quite common in several emerging markets as I suppose most people are consuming at the needs end of the basket rather than at the wants end. So you tend to be more influenced by these, I suppose, commodities and therefore India was making the journey from higher structural inflation towards a lower structural inflation. 7% was quite high, but if you look at India's inflation average over the last few years, it's dropped to four to 5%. So structurally making the journey lower. The spike in 2022 influenced India's inflation as well. But now you've got CPI, the latest reported number was 3.65, whereas cash rates are about six and a half. So that's quite a high positive real rate, and we think there is scope for the central bank, which has always been cautious on inflation, to cut rates either late this year or early next year.

Paul O'Connor:

Yeah. Well, I guess given the inflation or CPI growth has typically been about two thirds of a country's cash rate, I can imagine there could be room for a 1.5 To 2% cash rate cut in the Indian economy there, Mugs.

Mugunthan Siva:

That's right. I mean, typically they don't want an environment where the currency is weakening too much by, I suppose, having a low cash rate. India is obviously a country that requires on capital inflow, so I think they would be a laggard in terms of rate cuts, but it's now almost a compelling proposition that they could cut rates and still enjoy a robust growth environment.

Paul O'Connor:

So maybe moving from monetary policy to fiscal policy, what are the priorities of the Modi government from a fiscal policy viewpoint?

Mugunthan Siva:

As a government, they have been actually quite diligent on fiscal policy. One of the key drivers of spending has been the GST, which was implemented in 2017. The GST after being initially problematic because it was really implemented without any warning and compliance costs were quite high and it was quite hard, particularly for the micro, small and medium enterprises, has now led to an environment where collections are rising rapidly, firstly through economic growth being strong and robust, but also greater level of implementation, greater accountability. So these GST collections are leading to greater availability of funds for growth and CapEx and management of the fiscal deficit. So post the pandemic, the fiscal deficit rose quite high like it did in many economies as governments injected stimulus and spending into the economy to barbell against the lower end of the population pyramid going through much pain and suffering. But also what the Indian government did quite well during the pandemic is keep some funds aside for spending when growth started to surface so they could boost those growth initiatives. They adopted a barbell approach which worked successfully and has now got them forecasting a fiscal deficit down to about 4.5% by FY26.

Paul O'Connor:

So maybe can you provide a few comments on corporate governance and the strength of the Indian regulatory authorities? And I guess particularly in the developed world, we've heard in some emerging countries areas of concerns around governance, China obviously being one, and potentially a lack of understanding of the shareholder and the rights of the shareholder in China. So can you make a few high level comments on Indian corporate governance?

Mugunthan Siva:

Yeah. I would say that part of the premium of investing in Indian equities in the sense that the part of the return generated has come from a shift towards improving governance. So the regulator, which is the Securities Exchange Board of India, it's called SEBI, has been noted as one of the quite strong regulators when it comes to countries not just in emerging markets, but more broadly. And a lot of that has led to do with improving governance principles, incorporating more independent directors on the board, incorporating greater diversity on the board, ensuring that the independent directors go through a proper test before being appointed so they're not just relatives of the family. All these governance conditions on protecting minority of shareholder interests have improved. One of the key concerns for several emerging markets and India is the fact that there is a large amount of family ownership. So founding families, founding promoters on average are about 40% ownership of the stock market. So whilst that can be a strong driving force of having an owner family structure, it can also lead to some governance issues of family structures, not understanding evolution of a business and the need to perhaps focus on minority shareholder interests. So the regulator has been working hard on creating that true separation between ownership and management and improving an environment for minority shareholders which make it more conducive to investing.

Paul O'Connor:

And possibly a double-edged sword there that it's a well-worn path, I guess. The emerging countries and even developed countries and companies are founded and they grow and then they become listed. And there's that balance of corporate governance, but there's also the positive in terms of still being founder run and focused in what the business does. And I know more and more fund managers follow that theme, have founder run companies there. So it's probably one where it's important to have some level of active management to understand the governance is sound, but then also to understand the alignment that a founder has with the longterm success of a business.

Mugunthan Siva:

Absolutely. Activism is an important component because when you've got 40% being held by the family, sometimes there's a belief that activism doesn't play a role, but that's been the focus through protection of minority interests, that activism can play a broader role in enhancing protection and governance.

Paul O'Connor:

So from a portfolio construction perspective, if I'm considering allocating to Indian equities in a diversified portfolio, what's the correlation between Indian equities and broader global equities or perhaps the MSCI World and is the market being driven I guess by internal or external I.E. export led growth?

Mugunthan Siva:

Yeah, the first part of the question, I think India has a lower correlation to MSCI World being firstly an emerging market, but more importantly being driven more by local demand, which goes to the second part of your question. When you look at emerging markets, if you take the MSCI EM and you take the MSCI World, the correlation has risen rapidly and has averaged about 0.8 for the last five to 10 years. And this is because a lot of the emerging market world has companies at the top of the capitalization list which are highly linked to the global revenue product cycle or linked to similar factors like information technology, financials as key sectors that drive their economy. Whereas in India, that's not necessarily been the case. There've been some companies that probably are involved in the, I suppose, global revenue, but when you look deeper down at the index, there is most companies, probably 75%, generating revenue from local demand environment. So that's why the correlation of India to the world and to emerging markets is slightly lower than some of the other, I suppose, broader emerging market allocation, which is one of the attractiveness aspects of Indian equities.

Paul O'Connor:

And will obviously then improve the diversification in a portfolio there. It's quite an interesting point you make there, Mugs, around the Indian economy being more internally driven, whereas I guess with globalisation and to your point, the global economic cycle and the big corporates all I guess moving in a similar wave, no matter what country they're domiciled from. I've always thought one of the unique natures of allocating to US equities is that the US economy can support itself without the rest of the world. And it strikes me that India may have some characteristics as well that could be a great diversifier in a portfolio. Maybe just moving back to the second half of the question there. So the economy's more internally driven?

Mugunthan Siva:

Yeah. Close to 60% comes from services. If you look at the divergent parts taken by India and China, they're both large economies, large population. China grew significantly faster really from 1990 onwards, and they were able to do this because they focused on manufacturing, they focused on construction, they focused on real estate. So building infrastructure, construction activity tends to be highly accretive to growth, and that's why they hit a peak of 12% GDP growth at one point in 2010. India has focused much more on, I suppose, local consumption, lots of areas which are not necessarily manufacturing related or export related. So financial services for example, was a significant growth area over the last 20 years, and that's been fairly much driven entirely by the financialization of India. It's important to look at this because no doubt at some point India will also want to become part of global supply chains, become more active from an export perspective. The early industry that's thrived in that space really to date is India's IT outsourcing and services.

Paul O'Connor:

I mentioned the dominance of the top 10 listed Indian companies in my introduction, so can you perhaps provide some insight to the listeners on the rest of the listed Indian equities market? Just maybe the number of listed companies, any gig sector biases, growth sectors amongst the different industries there?

Mugunthan Siva:

Yeah. I'll sort of make a broad comment across emerging markets overall that what tends to be at the top of the index in terms of a market cap weighted benchmark, be it MSCI Brazil or MSCI India or whatever country benchmark you look at, tends to be what was successful over the last decade. So when I look at India, the top 10 is full of consumption, information technology and financial services almost exclusively. Because those were the industries that propelled India's growth over the last 10 to 15 years. What tends to happen therefore is you tend to keep allocating to what was successful, whereas the story of investing in emerging markets is about growing addressable markets from smaller size to larger size. Markets that didn't exist 10 to 15 years ago that become more significant. And investing with large players in those industries really gives you the outsize returns rather than just beta of the index or index type returns.

So for example, in our funds, in the last couple of years, we've really benefited from an allocation to pharmaceuticals. Now, healthcare in the MSCI India is less than 5% because it's not necessarily been an industry that's been high growth and taken it to the top of market cap weighting. Another industry is real estate, which had less than half a percent in the index, but has been recovering strongly post-COVID. It's important that emerging market investors not just find themselves attracted to large heavyweight market caps, but also look at how to participate really in the true growth story.

Paul O'Connor:

Simplistically, in my mind anyway there, Mugs, the growth story's about the growth of the middle class and with the growth of the middle class, it's the growth of consumer staples. So credit growth, supermarkets, everything that we touch daily that I would've thought there's significant opportunity through investing in the Indian economy there. We've heard about digitalization, financialization, urbanisation themes in the Indian economy. Are these continuing and are there any new or rising structural themes in the economy?

Mugunthan Siva:

Yeah. I think those points are well made and they continue to play out. So just harping quickly on digitization, for example, one billion people now own a smartphone in India. They all have a national identity card. They all have a bank account. Over 50% of people have internet access. So this is making growth more inclusive and with a potential to accelerate at a faster pace, whereas previously perhaps 65% of India lives in rural regions and in rural regions, perhaps the inclusiveness of something like availability of credit and banking did not exist in the past. All these things have contributed to making the growth rate more robust and particularly with such a young population, technology in the hands of this population seeking to be aspirational has led to significant growth. You talked about what are the other thematics, infrastructure has to be one of the next key thematics.

Paul O'Connor:

So roads, rail, airports.

Mugunthan Siva:

Absolutely. Port, seaport. Indians haven't travelled so much from a aviation perspective, but now more of the budget is being allocated from staples, that is needs, towards wants. And part of the wants are I want to go overseas or I want to travel to my village location via a flight. So the improvement of infrastructure is definitely going to allow for a faster pace of growth, greater spending, reduction in the cost of logistics for businesses, which is going to have a profound effect on productivity.

Paul O'Connor:

Do you think the rollout of major infrastructure projects will be more like a public-private partnership or do you think it'll be funded by the government and therein obviously in PPP lies great opportunity for infrastructure investors?

Mugunthan Siva:

Yeah. So far most of the work has been done by the government and a few large C corporate players. The Adani Group, for example, which is a well-known in Australia, has been responsible for a lot of the rollout of the roads and ports and the government has spent significantly, particularly since the pandemic, on rolling out of infrastructure. And the next transition is the requirement for private enterprise and as you said, public-private partnerships to build what today is only about 20% of the infrastructure needs of India. So there's still a long way to go. This is also an opportunity, for example, for the Australian super funds or those looking for longer tail growth assets, greenfield, brownfield to participate. So I think the next 20 years is going to see a significant infrastructure growth and build in India.

Paul O'Connor:

So to the outsider, India appears to have quite a stable political environment these days with the BJP government and incumbent PM Narendra Modi being in power since 2014, as you mentioned earlier. Can you provide a few comments on the political environment and is the BJP continuing the strong economic reforms to support ongoing GDP growth?

Mugunthan Siva:

Yeah. So look, the first period from 2014 to 2019, India has five year cycles, was one where a lot of reform was implemented. There was some indigestion, but generally it was accepted that there was an attempt to improve India's growth profile, improve employment, and make positive initiatives towards putting India on the map as an economic power. The second five years was obviously impacted by COVID and the way the Indian government was able to manage the economy and pilot it towards initiatives like making India greater level of participation in global supply chains and accelerate perhaps some of the competitive advantages of India and put them on the map led to the fact that in the 2024 elections, which are only two months away, the Modi government or the BJP government led by Modi won the election, but they won with a lesser majority and I'll explain why that is.

So there was a thought process that perhaps India was getting too controlled, too dictatorial perhaps in its initiatives where only large wealthy families were seeing the benefit of the growth story. And essentially the election hinted at democracy being pushed to the forefront because a lot of the rural areas and areas which were typically BJP strongholds actually voted against. So you have this time a government with a lesser majority than in the last five years, but we think that's actually going to be positive because India in a balance and under a coalition government has actually led to better equity market returns in the past because it's not so concentrated on certain areas and takes into account that the bottom end of the pyramid also needs to participate more and more as we see progression.

Paul O'Connor:

And I guess quite succinctly that highlights the benefits of democracy and again why the Indian economy is an attractive destination in my viewpoint for investors. I made some comments in my opening about the low level of exposure Australians have to Indian equities. So what do you believe are the pros and cons of using different avenues to Indian equity exposure, i.e. relying on a global equity fund, an emerging market fund, an fund or an Indian specific fund to provide that exposure to the Indian economy?

Mugunthan Siva:

So we look at it this way. You can get, let's say 2% in a global fund because the acqui weight for India is about 2%. And we know that when you look at attribution results, generally managers don't take big bets on low weight countries in a benchmark. So generally in a global fund, you might find yourself with a small allocation, one or two stocks in India. In an emerging market fund, now that the weighting of India is about 20%, you'll probably find closer to five to 10 stocks. They tend to be the more large and liquid.

Paul O'Connor:

Yeah. Those large mega caps, I'm guessing.

Mugunthan Siva:

That's right. And as we discussed earlier, that tends to be consumption, information technology or financial services because they've been the success stories of the last decade. And then Asia funds are similar in their structure to EM within India having probably 25% weight. So you will get some punchiness around it. Our view is always that to invest deeply in India and to really extract the true growth story, you need depth and local investors who understand things like governance that we discussed before so that they can differentiate between what will be the successful growth stories and what may not.

Paul O'Connor:

And I imagine you just wouldn't get the correlation benefits of that Indian exposure within an international equities fund or within a EM fund that a dedicated Indian fund will provide to an overall global equities portfolio. And maybe on the balance or the other side of the coin, what are the key risks an investor needs to consider before allocating to Indian equities, Mugs?

Mugunthan Siva:

Yeah. Anytime it's a single country, I think that's where people tend to be fearful versus a broader mandate like say emerging markets because the diversity of spreading across several countries seems to appeal. Therefore, when we're looking at the risks, they tend to be what might affect India specifically. And we can probably narrow that down to rising oil prices. India does import close to 80% of its oil requirement, and we are still in a phase where we're at the early part of transition to renewables. Of new capacity that's being added, 80% is renewables, but the base is still very much fossil fuel driven. So a rising oil price can be harmful to the balance sheet of India. Anything which is unsettling to the geopolitics or specific politics of India will always cause disruption. And then any events that could have an impact, more so on India like COVID, we all thought COVID would be horrific for India given population density, but it didn't quite play out that way. So I think in summarising the answer to your question, India has become far more resilient than what it was to shocks external and local. And as the economy builds up a head of steam, we think it's fairly balanced and diversified to be able to cope with some of these shocks much better.

Paul O'Connor:

And finally I need to ask, is the Indian population as obsessed with cricket as we're led to believe? And I guess I'm a bit of a cricket fan, and I guess my thoughts are that as India is the most populous country, it's simply only a matter of time before they become world champions and unbeatable, in fact, in all formats of the game.

Mugunthan Siva:

Yes. I think if they could rub Australia out, then they would be unbeatable. But Australia tends to be a thorn in their side like we saw in the last World Cup. So is India obsessed with cricket? Yes, and more so I remember when I lived in India going to a shop while Sachin Tendulkar was batting meant that you got no service because everyone was watching the game. When you went to the games, it was fully packed and the cheers were only for the local Indian favourites. So it's very much something that the pride of the nation is placed on how successful this team is. India hasn't really necessarily been successful in the Olympic sports, so cricket is basically the religion.

Paul O'Connor:

Understood. All right. Well, we better bring the podcast to an end there, Mugs. So thank you very much for joining us on the Netwealth Portfolio Construction Podcast and taking us on a really interesting journey. I've felt the conversation over the last 40 minutes through I guess the Indian economy, the growth areas in the economy, the political environment and insights into the share market, and I guess the different industries, the representation and the growth opportunities there. So I think as a key point to take away in my mind anyway, was the comment you made around that the Indian economy is more internally driven in terms of its GDP growth and hence therein, I think in my mind, provides some real correlation benefits to offshore investors and why I think people should consider an allocation to Indian equities in their portfolio. So thank you very much for your time and your insights, Mugs, and maybe I look forward to an update in a couple of years time from you about the Indian economy and how your fund is going.

Mugunthan Siva:

Thanks very much, Paul. Really appreciate your time to put this together and I look forward to the chat down the track and look forward to the summer of Australia versus India in the cricket.

Paul O'Connor:

Absolutely. And to the listener, thank you very much for joining us again on another instalment of the Netwealth Portfolio Construction Podcast. I hope you found the discussion as interesting and as enjoyable as I have today, and I wish you all the best and look forward to joining you on the next instalment about podcast series.