Never before in the last 100-200 years has India really been an asset class and now for the first time, India has become an asset class among fund managers globally and they will not desert it entirely although they may reduce the exposure at some point." So said investment guru Marc Faber, in a recent interview to a television channel.
The breathtaking pace at which the Sensex has hit the 9000 mark, must have left many of you quite stunned. In fact, the entire run in the markets this year has been way beyond expectations. As Faber says, global fund managers are discovering India with a vengeance. So, if you're in the market, you're onto a good thing.
With the Sensex now trading at a price/earnings (P/E) multiple of 17 times estimated FY06 earnings, the market is far from cheap. Even if one were to consider the estimated rolling 12-month forward earnings, the multiple would be around 16 times. If one were to exclude metals oils and cyclicals, the multiple would be even higher at around 20 times forward.
At a disaggregated level too, stocks are trading at even higher forward multiples of between 22 and 25, which are barely in line with expected earnings growth for the next couple of years.
Some more evidence of India's rarefied valuations is found in the price to book (P/B) for 2005, which at around 4.6 times, is one of the most expensive in the world. So, all in all the market is far from inexpensive.
In fact, one brokerage recently billed India as one of the most expensive markets in the world in terms of price to book, though it conceded that the valuations were backed up by high returns on equities (RoEs) of tech firms. For instance, markets such as China-H, appear more attractive at present, given the strong growth in those companies.
As a result, global fund managers could perhaps refrain from bringing in large sums immediately, preferring instead to invest gradually. As such the next six to twelve months could be disappointing in terms of returns from the broad market.
The kind of returns seen in 2005---approximately 35-40 per cent between January and now ---are unlikely to be repeated in 2006. However, foreign institutions are unlikely to withdraw money and so, over the longer term, the markets should return 15 per cent annually.
As Anup Maheshwari, Head Equities at DSP Merrill Lynch AMC, says, "Investors need to have a medium-term approach as at these levels, the volatility in the market could increase. Given the strong flows expected overtime, equities should outperform other asset classes."
Clearly, interest in India is unlikely to wane in a hurry. There are good reasons why global fund managers are flocking here. Essentially, the fundamental story still remains a good one.
The reasons for buying into India: a secular sustainable 7 per cent GDP growth, favourable demographics fuelling consumption demand, comparative labour and skill advantages in areas such as technology and pharmaceuticals, a big domestic market.
And last but not the least, a large universe of stocks, across sectors, to choose from . Few economies in the world today are as attractive an investment destination as India is. However, India is still undiscovered.
With a market capitalisation of $500 billion, it accounts for just 1.26 per cent of global market capitalisation. That may be higher than China and Taiwan but it's still small.
That's also because of earnings expectations. While companies are unlikely to grow their profits at 25-0 per cent as they have in the past two to three years, and the slowdown is already happening, analysts agree that a 15 per cent earnings growth over the next few years appears to be sustainable.
One study by a foreign brokerage shows that consensus expectations for 2006 estimate earnings growth for India at 15 per cent, compared with 15 per cent for Korea and 25 per cent for Taiwan.
However, in the case of Taiwan, earnings growth has been very volatile, whereas in India, they are coming off a high base, which makes the growth more creditable. Besides, analysts agree that Indian RoEs are superior to those of companies in other markets.
While net FII inflows to India in CY2005 have crossed $8 billion, more could flow in over time.
Global fund houses, some of which have assets of $400 billion-$500 billion, have barely allocated a couple of percentage points for India. Even if that doubles, it would translate into big amounts.
The other compelling reason to invest in India is the growth of the domestic fund base. Equities have remained a small fraction of total domestic household savings in financial instruments at around 1.5 per cent.
However, with changing demographics, higher disposable incomes and the lack of alternative savings instruments, the inflows into domestic mutual funds should gather pace.
That would definitely mean a more stable stock market. To sum up, the markets may seem overheated and expensive, but there are enough good reasons to stay invested.
