Asset allocators globally have often grappled with vastly differing valuations within emerging markets (EM) at a headline level. Indian equity markets have consistently commanded a premium of 50-80% to that of the EM average on a private equity basis, writes Ayush Abhijeet, adviser to the Ashoka India Equity Investment Trust.
High growth is often cited as the key reason. Indeed, not only has India has delivered 6-6.5% real GDP growth over the last two decades, higher than most of its EM peers, but it is also projected to be the fastest growing major economy over the coming years as well, as per estimates by World Bank and IMF.
India offers once in an era multi-generational opportunity as it marches towards being the third largest economy by 2030. There are a few structural levers at play, favourable demographics being one of them – globally, one in every four people entering the workforce over the next decade will be from India.
Recent government policies, including the thrust on ‘Make in India’ is a near-term tailwind. India’s transition towards industrialisation is also a relatively newer phenomenon compared to other emerging economies like China, Korea, and Brazil.
More than 50% of India’s workforce is either involved in agriculture-related activities or is part of the informal sector, and thus, productivity gains from formalisation can be a big tailwind.
Other factors
However, growth cannot be the only factor leading to premium valuations. For example, China, which has grown at a scorching pace of 9% over the last two decades, propelling the economy to being the second largest globally, has consistently traded at a valuation discount to India and many other EMs over long periods.
To draw an analogy, within a sector or market, companies with the best corporate governance practices command premium valuations. Absent adequate corporate governance, a fast-growing company is valuable but only for the controlling shareholders and not for the minority shareholders.
Substitute democracy with governance and a similar dynamic is at play when evaluating valuations at the country level – it is often countries with strong democracies that generally have well-established independent institutions which trade at a higher premium to countries with less democratic or more authoritarian regimes.
Where standards of corporate governance are inadequate, there is a significant risk that cash flows may be diverted by controlling shareholders to the detriment of minority shareholders. As a result, the assumption of minority shareholders having a proportionate right to cashflows is weakened, which is why such companies trade at discounted multiples compared to their better-governed peers.
Similarly, jurisdictions where contractual property rights (read: cash flows) are prone to appropriation or arbitrary regulatory actions, tend to trade at a discount to jurisdictions where adequate separation of powers ensures vigorous enforcement of such rights.
Democracy
In our view, India is consistently rated as one of the most democratic countries because of the institutional separation of powers and the robustness of its soft infrastructure.
Adequate institutional checks and balances have also given India the unique distinction of being among the few EMs with no instance of a currency crisis, sovereign default, or political coup in many decades.
Investments in emerging economies are often subject to such risks, but the absence of such debacles in India results from its robust infrastructure, which in turn reduces the country’s risk and contributes to its premium multiples.
These are highly underappreciated and often overlooked attributes when assessing India’s premium valuations. It is also important to note that amongst all large EMs, India’s tenure as a full democracy is the longest at 72 years.
Quality of assets
Apart from governance, the quality of underlying assets of a company has a bearing on multiples. Similarly, in the context of an entire market, it would imply the heterogeneity and diversity of underlying sectors and stocks.
There are some markets that are dominated by onesector or even one stock. For instance, in one major emerging market, the highly cyclical tech-hardware stocks make up 69% of the index weight. Similarly, there are country indices which are heavily swayed by prices of a specific commodity such as oil or metals.
In fact, there are many EM indices at the country level portray unfavourable characteristics such as a high concentration of a sector or group of stocks, which makes earnings susceptible to a certain event, for example, one factor could be the boom and bust cycle in commodities.
On the other hand, India has the most diversified sector mix with fair representation of most sectors. Unlike most other EMs, no single sector dominates the Indian index. This is why India’s earnings have displayed more resilience in downcycles (2008, 2015, 2020) compared to other EMs.
While it is true that there are other EMs that are well-functioning democracies and some that have a well-diversified corporate universe, there are yet others where the projected GDP growth rate is amongst the highest in the world.
However, as a combination of the above three factors, India presents the most compelling opportunity. After all, for an investor, what is most important is the sanctity of property rights, and India, with its independent institutions, provides a very high degree of comfort.
This article was written for International Adviser by Ayush Abhijeet, adviser to the Ashoka India Equity Investment Trust.
