Kotak Mahindra bets on IndiaÆs economic growth

Nitin Jain is the head of long-only equity strategy of the London-based asset management company Kotak Mahindra UK, which has been investing in India since 2003. As of November last year, the company had around $3 billion in assets under management and $800 million in discretionary assets.

While the Kotak MahindraÆs investment strategy has a growth bias, it has a strong emphasis on scalable businesses, management ability to manage growth and valuations. In other words, the company is a buyer of growth at a reasonable price. Dubai-based Jain spoke to AsianInvestor about the prospects of IndiaÆs stockmarket, which is emerging to be the new favourite in Asia for many international fund managers.

India remains among the most compelling economic growth stories in Asia. Do you believe that IndiaÆs economic potential is well represented in the local stockmarket?

India is one of the few large economies that have been estimated to continue its growth trajectory in the coming years. We believe this strong economic growth translates into opportunities for investment in three broad themes: domestic consumption by a young workforce benefiting sectors like financial services, consumables, automobiles, real estate, and telecommunications; sectors benefiting from the strong infrastructure and corporate capex cycle; and export-oriented sectors like IT services, pharmaceuticals, auto ancillary, textiles, and gems.

With 5,500-plus listed entities in Indian exchanges, there is no dearth of companies to invest in, to capitalise on the opportunities. While there are close to 200 companies with more than $1 billion in market capitalisation, there are about 900 companies with market capitalisations in the range of $50 million to $1 billion. We look into this entire universe of about 1,000 companies for investment opportunities.

The Bombay Stock Exchange Sensitive Index rose 47.2% in 2007, making it among the best performing equity markets in Asia. How do you expect the market to perform this year?

Indian equity markets witnessed a re-rating in 2007, lead by stronger-than-expected corporate earnings and abundant liquidity, especially by foreign institutional investors in the aftermath of the sub-prime crisis. While in 2006, the market was marginally ahead of earnings growth, in 2007 the price-to-earnings ratio of the market expanded by almost 25%. With large-cap indices trading at close to 20x fiscal year 2009 earnings, we believe that there is limited scope for price/earnings ratio re-rating and expect the markets to track the earnings growth this year.

What are the opportunities you see arising from the Indian stockmarket this year?

We believe investors will continue to back sectors where there is potential for large market cap creation such as financials, insurance, oil, gas, utilities, real Estate and telecommunications. Within these sectors, there could be further interest in public sector companies where there is some intent for private participation in some of their ventures or a move to expand their addressable market.

We are currently underweight on sectors which have significant currency risk, namely, IT services, auto ancillaries, textiles and pharmaceuticals. We are also underweight towards automobile stocks and neutral towards consumer non-durables. We favour financial- and infrastructure-related stocks and continue to fancy companies having strong entry barriers, high operating leverage and strong execution capabilities.

What are the main challenges of investing in India this year?

Historically, the biggest challenge of investing and doing business in India was the lack of quality infrastructure. While infrastructure concerns are getting addressed with public and private initiatives making significant headway over the last few years, new challenges have emerged.

In 2007, investors started assigning significant value to various businesses and assets, popularly known as embedded value, on the balance sheet of various companies. The challenge for these valuations to be sustained would be execution and operation of these assets. While an appreciating rupee is a positive for foreign investors, a lot of export-oriented business models have to be significantly altered from mere cost-arbitrage models to value-enhancing models. The most important challenge for business across the spectrum would be talent management to execute these projects.

Last year, IndiaÆs stockmarket was driven by unprecedented foreign investments amounting to $16.95 billion. Do you expect foreign investors to continue to drive IndiaÆs stockmarket higher this year or do you see their participation tapering off?

It is our belief that majority of foreign institutional interest continues to remain in the larger capitalised companies, and therefore there is relative under-ownership of mid-cap companies. Foreign interest in Indian equities is likely to be sustained this year as corporate earnings are expected to remain strong and India emerges as one of the few economies with a resilient growth model. We expect domestic liquidity, lead by insurance companies, to be a dominant source of liquidity from this year onwards.

We understand that you are managing three funds that invest in India: the Kotak Indian Growth Fund, the Kotak India Concentrated Growth Fund, and the most recently launched Kotak Indian Infrastructure and Realty Fund. What are the top three holdings of each of those three funds?

Our top three holdings are Reliance Industries, Bharti Telecom, and ICICI Banking in the Kotak Indian Growth Fund; Reliance Capital Limited, Patel Engineering, and Development Credit Bank in the Kotak Indian Concentrated Growth Fund; and GMR Infrastructure, Suzlon Energy, and Larsen and Toubro in the Kotak Indian Infrastructure and Realty Fund. The portfolio holdings change continuously.