Market review

Indian equities proved resilient over the six months under review, with the market being one of the few global bourses outside of the Middle East to remain in positive territory. The size of the domestic economy, moreover, provided a buffer against any weakness in global demand. However, against a backdrop of post-pandemic economic recovery, spurred on by growing consumer appetite for goods, services and travel, rising prices became a cause for concern. It was exacerbated by the ongoing conflict in Ukraine that sent oil and commodity prices soaring. Despite being a net importer of oil and certain commodities, India has been able to withstand the impact of inflation aided by supportive measures from the government and the central bank. With high frequency data showing signs of steady improvement over the period, India’s relatively stable position in an increasingly tense geopolitical landscape has further provided relief to investors.

Portfolio overview

While the portfolio delivered a positive absolute return, it lagged the Benchmark as positive allocation did not fully offset negative stock selection. 

Principally, we believe in investing in businesses that are backed by reputable promoter groups, with a track record of delivering value to all shareholders. Hence, the Company’s portfolio does not hold positions in any of the Adani Group companies, which has held back relative performance. We view the Adani entities as lower quality stocks, given their weak financial track records, highly over-leveraged balance sheets and major ESG concerns, which make them extremely risky bets in our view, and ones that we are not prepared to expose the portfolio to. These entities, unfortunately, have contributed to over half of the portfolio’s relative underperformance of the Benchmark over the six months. Shares of Adani Enterprises, Adani Transmission, Adani Total Gas and Adani Green Energy – most of which are classified under the utilities sector – outperformed the Benchmark as the group announced a series of aggressive expansion plans and corporate actions spanning multiple industries. 

Drilling into the attribution, additional underperformance was due to several factors that we outline below. Weak stock selection in utilities also negatively impacted through the portfolio’s holding in Azure Power Global. A series of increasingly concerning events through August relating to late filing of the annual financials, an abrupt resignation of the recently-appointed CEO and a whistle blower led to our rapid exit in the stock. While this was a small position in the portfolio, it has been disappointing, not least because the company had high quality investors on the register, and we had undertaken significant due diligence on the company ourselves and viewed it as a high-quality exposure to the Indian renewables sector. Following this episode, ReNew Energy Global will be our sole renewables exposure. We have had a preference for ReNew given its operational execution, scale and funding status and this has been reflected in our relative positioning. After our detailed discussion with the company and others in the industry, there are reasons to believe what happened with Azure Power Global is an isolated case that surprised many. ReNew has strong checks and balances in its internal controls and there are few levers for manipulation in operating assets, which makes up the bulk of its portfolio. Fundamentally, ReNew has been executing in line with our expectations since initiation. We have also been encouraged by the Central Government releasing new rules to address the receivables issues in the sector, which is incrementally positive for the cashflows of ReNew. 

Another contributing factor to the relative underperformance has been the growing fears of a global recession that would likely have an impact on technology spending. While we had taken some profits from our IT services holdings, our overall overweight exposure to the sector detracted from performance during the period. Despite near-term challenges, India’s technology sector remains attractive, owing to robust demand for knowledge-based IT services both at home and abroad and we judge our core IT services holdings Infosys, Tata Consultancy Services and Mphasis to be high quality names, with clearly articulated sources of competitive advantage, healthy balance sheets, impressive management teams and excellent corporate  governance standards.

As India continues to re-open in a post-pandemic world and as the global supply chain disruptions ease, cyclical discretionary stocks, such as those in the automobiles sector, have rallied as new car sales rose steadily in response to pent-up demand. Your Company holds Maruti Suzuki, which outperformed on the back of a strong orderbook and new model launches, including a next generation of compact SUV, the Vitara Brezza. However, not holding Mahindra & Mahindra in the early part of the review period proved costly as its share price rose following a set of robust results. We had favoured Maruti Suzuki as the undisputed market leader in the passenger vehicle market with strong support from its parent company. Through the period, we had been adding to our position in the company that should benefit from the cyclical recovery. With our positive view on the sector’s long-term outlook, we added Mahindra & Mahindra as a complement to our holding in Maruti Suzuki. Mahindra & Mahindra has a stronger position in SUVs, a new line-up of electric vehicles and has demonstrated better capital allocation that should drive an increase in its valuation.   

Finally, your Company’s allocation to the financials sector did not fully offset stock selection as the portfolio’s exposure to Piramal Enterprises weighed on performance. Piramal disappointed on a weak set of results though, in more positive developments, the group has now de-merged its pharma business to create a cleaner corporate structure, with two listed companies, a financial services business and a healthcare business. The portfolio now holds shares in both entities. Notwithstanding the near-term weakness in both businesses, we believe this structure will provide greater clarity and transparency to investors, and pave the way for a re-rating in both stocks over the medium term. Elsewhere, PB Fintech, which operates the online insurance platform Policybazaar, sold off on negative sentiment towards pre-profit companies in India, and across the region. 

The portfolio’s core, well-capitalised holdings in ICICI Bank and Kotak Mahindra Bank outperformed in a rising interest rate environment and amid expectations of an improving credit cycle. Both lenders delivered good results that were underpinned by healthy loan and fee-income growth. Among insurance names, SBI Life Insurance also outperformed after posting strong quarterly results that demonstrated insurance premium growth and margin uplift, driven by improvements in the company’s product mix and through good execution from management.

On a positive note, your Company’s underweight to the energy sector was also the biggest contributor to relative returns. Global energy prices came under pressure as even a relatively strong US dollar could not compensate for investors’ mounting fears over a global recession and its impact on energy demand. Not holding industry bellwether Reliance Industries was beneficial as its share price pulled back following recent outperformance. We do not hold Reliance for similar reasons as the Adani group (see above). Your Company’s exposure to oil and gas logistics company, Aegis Logistics staged a strong share price rebound during the period on robust gas distribution sales. Meanwhile, the portfolio’s more defensive holdings, particularly in the consumption sectors, fared well despite increasing volatility in the market. The share price of Hindustan Unilever, the largest, fast-moving consumer goods company in India, recovered from its March lows with resilient margins, thanks to a strong balance sheet, wide distribution channels and its ability to pass on costs. A benign monsoon and the festival season further supported solid demand growth. Likewise, Crompton Greaves Consumer Electricals also saw its share price rise on resilient demand, which added to your Company’s relative gains. 

Portfolio Activity

We have taken steps to reposition and refresh the portfolio to keep up with changing market trends in the near-term, while staying true to our philosophy of investing in the highest quality companies that are fundamental to India’s long-term growth. Aside from Mahindra & Mahindra, we introduced Delhivery, the largest, fastest-growing and fully integrated logistics player in India, with all verticals exhibiting very healthy growth. The company is disrupting the domestic logistics industry through its uniquely successful network design, tech and automation capabilities, business integration and significant time and data advantage. 

We also initiated ABB India, the listed subsidiary of Zurichbased multinational corporation, ABB. It designs, manufactures and distributes industrial equipment to a diversified base of industries in India. ABB India has a strong management team and technology know-how and it is very familiar with the local market, which positions it well for the recovery in India’s industrial capex as  the economy recovers from two years of weakness related to Covid-19 (see the case study section of this website for further details). 

To allocate funds to more compelling opportunities elsewhere we divested from Zomato and Star Health and Allied Insurance. At the same time, we took profit from our positions in ITC and Larsen & Toubro (L&T). Finally, we  also sold Azure Power Global for reasons that we discussed above.

Environmental, Social and Governance

Over the six months, we continued our engagement with companies on various ESG matters. Holding discussions with Affle India on aspects of labour management, human rights and corporate governance. Further, we spoke with Godrej Properties about its green strategy for its residential development projects, firm-wide safetymanagement certification and various board issues. We encouraged both companies to take the necessary actions to improve their ESG credentials, and will follow up with them on progress. Lastly, in a meeting with UltraTech Cement, we noted improvements on the company’s decarbonisation efforts. The company was planning to reduce its carbon (CO2) emissions from 580kg per tonne of cement to 462kg per tonne by 2032, with the main focus on using green energy as a fuel source.

Outlook

India remains one of the fastest-growing countries in the world, and is expected to deliver one of the highest earnings growth stories this year, supported by a progrowth budget for the 2023 fiscal year. With the Covid-19 pandemic under control, India’s economy is showing signs of recovery: credit growth is accelerating, the real estate market is seeing momentum, infrastructure is being built and consumer spending is gradually improving. Some of the domestic headwinds, including rising inflationary pressure, appear to have moderated slightly in recent months. That said, prices remain above the central bank’s upper tolerance limit, and if interest rates continue to rise, it would eventually have the effect of weighing on the consumption recovery trend. Further, international developments, including the potential onset of a global recession, as well as geopolitical escalations would  have an impact and test the resilience of the  domestic economy.

We expect our core quality holdings to continue to deliver resilient compounding earnings growth over the medium term, come what may in terms of macro conditions. The consistency of earnings growth within the portfolio remains healthy and fundamentals, including pricing power, strong balance sheets and the ability to sustain margins, remain solid. We maintain confidence in the experienced management teams in place at these companies and in time expect these factors to once again be reflected in favourable share price performance.

Kristy Fong and James Thom

Investment Managers, 2 December 2022

 

Discrete performance (%)

Total return; NAV to NAV, net income reinvested, GBP. Share price total return is on a mid-to-mid basis. Dividend calculations are to reinvest as at the ex-dividend date. NAV returns based on NAVs with debt valued at fair value. Source: abrdn Investments Limited, Lipper and Morningstar.

Important information

Risk factors you should consider prior to investing:

• The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
• The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
• The Company may charge expenses to capital which may erode the capital value of the investment.
• Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
• There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
• The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.

Other important information:

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.

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