Indian equities' persistent performance

Over the past 30 years, despite a difficult backdrop, equity market returns are striking

I read an interesting report by BofA Securities recently, lamenting the performance of emerging markets (EMs) and Asia, excluding Japan. The report tracked 30 years of equity-market performance and the results were quite startling. China was added to the MSCI equity index in December 1992. Since then, (almost 30 years of data) Asia ex-Japan equities have delivered a dollar return of only 3.7 per cent per annum (excluding dividends). In contrast, the US has delivered 7.8 per cent returns per annum. Japan itself had a return stream of only 1.1 per cent and Europe was 4.1 per cent. EMs as an asset class delivered 3.9 per cent.

Clearly, the US has been the only game in town and despite going through the global financial crisis, tech bust and housing crisis, equity returns in the US have set the bar for everyone else to follow. If you break down the Asia returns further, China was the worst performer at (-) 1.4 per cent and India the best at 7.3 per cent dollar returns over a 30-year period. The next best markets in Asia were Korea and Taiwan, which delivered dollar returns of 4.5 per cent and 4.4 per cent, respectively, over this period. India thus outperformed its closest peer in Asia by almost 300 basis points per annum over a 30-year period!

China having a return of (-) 1.4 per cent per annum over a 30-year period seems absurd given the growth and prosperity we see there today. It is partly a reflection of the disastrous performance of Chinese equities over the last few years and also an index composition issue as initially we mostly saw China’s state-owned enterprises in the benchmarks. China has also delivered huge returns for investors in the private equity and venture capital space, which is not captured in the listed equity benchmarks. However, for a passive investor into China, (-) 1.4 per cent per annum is the return they would have achieved, had they been invested from the day China entered the MSCI benchmark.

How can these poor returns make any sense? Remember this data is for a 30-year period, a time when Asia ex-Japan outperformed economically on every single parameter. As the report points out, Asia has actually outperformed the US very significantly in terms of economic growth over this period. The US delivered nominal gross domestic product growth of 4.5 per cent compared to 9.5 per cent for the countries of Asia ex-Japan since 1992. This translated into revenue growth for the companies in Asia of 15 per cent, compared to 6.5 per cent for American companies. The strong revenue outperformance led to net profits growing at 12.6 per cent per annum for the Asian stocks compared to 10 per cent for US stocks.

Illustration: Binay Sinha

 

The problem, however, becomes obvious in the earnings per share (EPS) numbers. Despite delivering profit growth of 12.6 per cent, EPS growth for the Asian equities was only 4.4 per cent, compared to 8.2 per cent for the American companies (source: BofA securities). Dilution destroyed the returns ultimately delivered to investors. This only goes to show that in the end it is not GDP growth or even revenue/profit growth but EPS growth which drives markets. On this metric, Asia failed to deliver. It is the same story for EMs as a whole.

The excess dilution also reflects ultimately in the return on equity (RoE). Asian RoE’s were stuck at 11 per cent, compared to 15 per cent for the US. India has been able to match the US as dilution was far lower in India, than other Asian economies. The gap between index earnings at 13.7 per cent and EPS growth at 8.2 per cent was far narrower for India than the rest of Asia. Consequently, the RoE in India at 15-16 per cent was far higher, comparable to US levels. India never had easy access to capital, at least not in the early years and the discipline this lack of easy money brought is still visible. Indian investors are also far more conscious of capital efficiency, with a clear premium being given to companies which deliver high returns on capital. Show me the incentives and I will show you the behaviour! When one looks at India, it is striking that it is the best-performing EM country by quite a good deal over the last 30 years.  In fact, after the US, Sweden and Switzerland, it is the fourth best-performing equity market over the last 30 years (of substantial size and relevance).

Within the EM universe, the next best country (of size) is Brazil, which has delivered dollar-based returns of 6.2 per cent over the last 30 years. However, Brazil has been a very difficult place to be, with returns over the past 10- and five-years at (-) 5.7 per cent and (-) 5.6 per cent, respectively. What stands out for India is the consistency of performance. It is the best-performing EM on a 30-year basis and is among the top two when you look at 20-year, 10-year and 5-year returns as well. It is also one of the two significant EM countries where the returns are positive and above 6.5 per cent in dollars, whether you look at 30-year/20-year/10-year or even five-year data.

Most investors find India to be too expensive and thus are hesitant to invest more. This has been another year of significant outperformance to date. India is trading at a record valuation premium to its EM peers. There will be a year or two when the EM asset class comes back with a vengeance, India will most likely underperform then. However, the long-term data seems to show persistent outperformance. Keep in mind that this is a period when India was not always firing on all cylinders. We had the lost decade of earnings growth (2010-2020), weak economic performance over the last five years, and the IL&FS crisis. As we look forward to the next decade, most investors envisage a far better period for India than the last decade. One also envisages a golden era of entrepreneurship and wealth creation in the start-up ecosystem, which will fuel new company listings and a broadening of the market. India is where China was in 2007, in absolute GDP terms. Most feel we have a strong period of corporate performance and earnings growth ahead of us. As long as the capital discipline is maintained, which is a responsibility investors have to enforce, we should be fine. Earnings will be strong and translate into EPS. Even with multiple fade, given our starting point, we should be able to continue delivering reasonable market returns.

India is known for being a stock-pickers market and has historically been a market with far more compounders as a percentage of companies than other markets. Is it possible that the country itself may be the next big compounder? The last 30 years certainly indicate so. One can be a contrarian and view this sustained outperformance as the reason to avoid the country and its high valuations, or one can view the persistence of returns despite a difficult backdrop as the reason to make India a structural allocation. Looking at this data, my sense is more allocators are thinking of a structural India allocation as opposed to selling down the country.

The writer is with Amansa Capital