Why this top-performing stock market has fallen out of form

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Today’s episode looks at the prospects for investing in India, which has been a top-performing stock market over the past decade, and performed particularly very well following the Covid-19 pandemic. However, returns have cooled lately, with the average India fund down around -17.4% over the past three months, and down -15.8% over the past six months.

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To find out why this sell-off occurred, Sam Benstead recently interviewed Hiren Dasani, lead manager of the Goldman Sachs India Equity I Inc GBP fund, which was added to interactive investor’s Super 60 list of investment ideas earlier this year.

The interview also covers whether India’s stock market trading on a higher valuation than other emerging markets is justified, whether Donald Trump’s tariffs are a headwind for India, and Hiren makes the case for active fund management as opposed to investors owning the market through an index fund or exchange-traded fund (ETF).

Kyle Caldwell, funds and investment education editor at interactive investor: Hello. I'm Kyle Caldwell, this is On the Money, a weekly look how to get the best out of your savings and investments. Today's episode looks at the prospects for investing in India, which has been a top-performing stock market over the past decade and performed particularly well following the Covid-19 pandemic.

Just to showcase how strong the performance has been since the pandemic, over the past five years, the average India fund is up just over 86%, which compares favorably to the average UK All Companies fund, which is up 57%. However, returns have cooled lately with the average India fund down 17.4% over the past three months and down 15.8% over the past six months.

To find out why the sell-off occurred, my colleague Sam Benstead recently interviewed Hiren Dasani, lead manager of the Goldman Sachs India Equity fund, which was earlier this year added to interactive investor's Super 60 list of fund ideas.

The interview also covers whether the fact that India's stock market is trading on a higher valuation than other emerging markets is justified, whether Donald Trump's tariffs are a headwind for India, and Hiren makes the case for active fund management as opposed to investors owning the market through an index fund or an ETF.

Sam Benstead, fixed income lead, interactive investor: Hiren, thanks so much for coming on our podcast. So, India has been one of the top-performing markets over the past decade. Your fund is up about 160%. The index up a little bit less than that. So, what's been behind the exceptional returns from Indian equities?

Hiren Dasani, lead manager of the Goldman Sachs India Equity fund: Thank you, Sam, and, very happy to be here today. If you think about India, it's a great long-term compounding story. And today, India is at about $2,500 per capita income. And over the last 20 years or so, the real GDP has grown at about 6% annualized. And when you look at annualized growth of about 6% real and 10% to 11% nominal, over time, it becomes a great compounding return story.

And the good thing about India is that still there is a long runway to go from here on as well. So, to put things in perspective, China is at $10,000 per capita income. India is at $2,500, and obviously developed markets like United States and Europe would be in excess of $40,000 or $50,000. So, there is a long runway to go. It's a very young demographic. It's a domestic consumption and infrastructure-driven story, and the growth is relatively less correlated. So, all these reasons make India a very compelling investment opportunity in my view.

Sam Benstead: And has this rally driven up valuations of Indian shares? So, how expensive are they compared to, say, the US or the UK, or actually other emerging markets too?

Hiren Dasani: Yeah. So, let me take that question in a couple of different dimensions. The way we think about India's valuations is that if you buy something which is a high-quality, consistent compounding business, you are never going to get it cheap. And India is one of those high-quality compounding growth stories. So, India's valuations always need to be thought of in that context, that is the growth much more structural? Is the growth less volatile? And, is the growth less correlated? So, because of these reasons of 'stronger for longer' growth and the less volatile nature of the growth, India's valuations always tend to be at a premium compared to the rest of the emerging markets.

Now, as things stand today, the valuations have cooled off somewhat because of the correction in the market over the last six months or so. And, valuations of India are at about 18 to 19 times one-year forward multiple as we speak today.

Those valuations are broadly more in line with India's last 10-year average history. If you look at the relative valuation premium of India, it is still trading at a premium to the rest of the emerging market, but the relative premium is now back to the last five-year or 10-year average, or even below on some of the metrics. So, India will always trade at a premium because of the longer runway for growth and less-volatile growth. But compared to its own history, valuations did get stretched to some extent last year, and over the last six months, we have seen healthy correction in the valuation.

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Sam Benstead: So, that correction in valuations, what's been behind that? Looking at your fund over a year, the returns have just turned negative, and this year's been tricky too. So, what's behind that correction in valuations and fallen share prices?

Hiren Dasani: Yeah. So, I think it is more about a combination of a soft patch of economic growth combined with the fact that the valuations had become rich to start with after two and a half years of very strong performance. Also, the fact that somewhere around September, the other markets in Asia, especially the bigger markets like China, started to look more attractive as there was a sense that there is a floor of economic activity which is being put in China by the policymakers. So, a combination of India-specific factors, like India had a slightly soft patch of economic growth between March and November last year. That was a combination of some slowdown in the government spending around the election time, or even after the election results were known. For a few months, the government machinery did not pick up in terms of execution, and the spending was a bit muted.

On the other hand, you also had higher interest rates, tight monetary policy, less liquidity in the banking system. So overall, monetary policy and fiscal policy both were quite restrictive, and that led to a soft patch of economic growth. It coincided with the fact that after strong returns in 2023 and 2024, the relative valuations of India over the rest of the region has also become more expensive compared to its own history. And as I said, China started to look a bit more attractive because of its own policy announcements.

So, all of this led to, I would say, lower valuations or the correction in the valuations over the last few months. And, the good news is that none of this thing is more structural. We are very confident that there is a long runway here. And the reason why we are not worried from an economic perspective is that the country's balance sheet is in very strong shape today. So, fiscal deficit, current account deficit, inflation, all of them are looking quite good.

Corporate balance sheets are also quite healthy, so we don't need to worry about any deep-rooted problem from a macro perspective. And valuation correction has been healthy, and it is proving to be a good opportunity for those who kind of missed out earlier on making India allocations.

Sam Benstead: And what types of companies have been performing well over the past decade in India? What are investors buying when they invest in the market?

Hiren Dasani: So, generally, when you come to India, you come for consumption-related businesses because many consumer categories are still [in their infancy]. And you can almost rewind the playbook of what has worked in some of the more middle-income economies over the last 15, 20 years. Many of those consumer categories, whether it is consumer appliances, autos, internet services, many of those consumer-related businesses tend to do much better as the per capita income increases and disposable income grows. So, consumer is one area where you always find a lot of interesting opportunities. Historically, financial services and IT are also the other two areas of interest.

And financial services because of under-penetration of the financial services, whether you look at banking sector loan-to-GDP ratio, whether you look at credit card penetration, mutual fund, or insurance penetration, whichever way you look at it, there is a huge under-penetration today.

Just think of it this way, [among the] 1.4 billion population of India, there are only about 50 million Indians who are investing in the domestic mutual funds. There are only about 100 million Indians who are investing in the equity markets. So, that tells you the extent of the under-penetration of financial services.

The other area of IT, obviously, India is home to a large pool of software talent and India has a lot of IT resources available. Historically, India has been office to the world, just as China has been the factory to the world, India has been more like an office to the world. And those are the sectors where historically the very interesting businesses are to be found.

Beyond these three sectors of consumer, IT and pharma, I would say healthcare is also a very interesting business in India, not only the domestic healthcare services like hospital chains and diagnostic chains and so on and so forth, but also generic pharma businesses. So, you might be surprised to know that 40% of US generic drugs are produced in India by volume. And India has good chemistry skills and India has competitive cost of manufacturing for the generic drugs. So, that is also one area of interest historically.

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Sam Benstead: You're based in Singapore, and your team is in India. Would you say India is a stock picker's market, and does it help to have boots on the ground when looking at companies? Or is it actually effective to buy a tracker fund in India?

Hiren Dasani: I think active management makes much more sense in India compared to a tracker fund. And the reason for that is that the average India manager tends to generate better alpha compared to, let's say, an average EM manager or average US manager.

Relatively, India is still a less-efficient market compared to the developed markets like the US or Europe. And that's where it makes sense to go for active management because there is an alpha generation potential. The second point is that the cost of passive versus the cost of active is also not very different. Unlike in the US, where the cost of passive is significantly lower, in a market like India, if you were to buy a passive tracking ETF versus an actively managed fund, the costs are not very different.

So, yeah, the alpha generation potential as well as the cost of active versus passive, on both those counts, it makes sense to go active in India.

Sam Benstead: China is the other big individual emerging market that investors often look at, and there are clear similarities, a similar population, for example. But why should India gain a place in portfolios over China? Why is it a better place to invest in China?

Hiren Dasani: I don't think we should compare it one versus the other. It's never China versus India. It can be China and India both over time. Historically, it's not that India has done well only when China has not done well. India has done well quite a few times over time when even China was doing well. So, both these economies will follow their own path. And, over time, I think India's growth is going to be less linked to China's growth. Unlike many other Asian economies, which are far more dependent on China, India is far more domestic-oriented. So, to that extent, India's growth will be less correlated to China's growth.

But, yes, there are parallels to be drawn there. If you look at over the last 20 years, whether it is in terms of per capita income, urbanisation, penetration of various consumer categories, electricity usage, you can look at a variety of economic parameters, and it feels very similar to where China was 20 years ago. So, if India were to follow the path of growth, which China has done over the last 20 years, I think there is a huge amount of value to be created. Now, having said that, there are differences in the economic models of India versus China.

China historically has grown much more on the back of manufacturing and real estate investments and infrastructure investments. India historically has grown much more on the back of services, consumption. Going forward, India is getting more competitive in manufacturing. China is trying to change its growth model more in favor of domestic consumption. So, there is some convergence [likely] to happen over time, but so far, the growth models have been very different.

And lastly, but also importantly, China is a single-party political system. India has a democratic set-up. And in a democracy, you always have greater kind of checks and balances, and the institutions become stronger over a period of time in a democratic set-up.

Sam Benstead: And where does India sit in the global economy? Is it exposed to tariffs from Trump or geopolitical tension? And could it keep growing regardless of these external factors?

Hiren Dasani: So, yes, there are trade negotiations going on as we speak between India and the US. There is worry [over] reciprocal tariff as President Trump has talked about whether that leads to higher tariff on Indian imports. If you put things in perspective, India's trade deficit is far lower compared to, let's say, some of the other Asian countries, which [have] a far higher trade deficit with the United States. I think the issue which is currently being negotiated is about greater market access to India on some of the categories of agricultural products and the others.

Our sense is that, yes, those negotiations can be lengthy and tricky but, eventually, there are no very big sticking points which will prove to be a hurdle of coming to an agreement between India and US. And I think geopolitically both countries are fairly well aligned. Both are democratic countries. The US sees India as its ally. And, yes, we think there are some trade negotiations which need to get sorted out, but it is not a big problem in our view.

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Sam Benstead: And to finish here, what would you say is the biggest misunderstanding investors typically have when investing and thinking about India?

Hiren Dasani: I think one misunderstanding or misconception we hear about India a lot is risk about corporate governance, whether minority shareholder rights will be protected or not, and so on and so forth. Sometimes you have one or two bad examples of corporate behaviour, which creates a lot of negative media headlines. But if you look beyond those media headlines, then the institutional framework of corporate governance is one of the strongest in India, among all the emerging markets.

Now the reason I say that is that if you look at the regulatory architecture, whether it is capital market, financial market regulator, banking sector regulator, those are all fairly independent regulators. The corporate governance norms, whether it is about minority shareholder protection, tender offer, related-party transactions, board independence, diversity on the board, net neutrality, carbon emission, on a variety of corporate governance-related norms, India has done a far better job in setting up that institutional framework and pushing the companies to adhere to that over a period of time. Some of them will do it in spirit, some of them will do it [to the] letter, but, that's where the role of an active manager lies. And, I think, by and large, the institutional framework is very healthy for corporate governance in India.

Sam Benstead: Hiren, thanks very much for coming on the podcast.

Kyle Caldwell: My thanks to Sam and to Hiren, and also thank you for listening to this episode of On the Money. If you enjoyed it, please follow the show in your podcast app and do tell a friend about it. If you get a chance, leave us a review or a rating in your podcast app too. You can join the conversation, ask questions, and tell us what you'd like to talk about via email on OTM@ii.co.uk. And in the meantime, you can find more information and practical pointers on how to get the most out of your investments on the interactive investor website at ii.co.uk, and I'll see you next week.

On The Money is an interactive investor (ii) podcast. For more investment news and ideas, visit www.ii.co.uk/stock-market-news.