Fund Friday: Virus headwind unlikely to stop India’s exponential growth potential

“If I gave you $1000 a day for the next 30 days or 1 cent on day 1, 2 cents on day 2, 4 cents on day 3, 8 cents on day 4 and so on for 30 days which one would you pick?”

In the first situation, you would have ended up with $30,000 by the end of Day 30. Picking the second option, on the other hand, would have netted you $5,368,709.12.

Table 1: Illustration of each option’s value from Day 1 to 30

Day	Option 1	Option 2
1	$1,000	$0.01
2	$2,000	$0.02
3	$3,000	$0.04
4	$4,000	$0.08
5	$5,000	$0.16
6	$6,000	$0.32
7	$7,000	$0.64
8	$8,000	$1.28
9	$9,000	$2.56
10	$10,000	$5.12
11	$11,000	$10.24
12	$12,000	$20.48
13	$13,000	$40.96
14	$14,000	$81.92
15	$15,000	$163.84
16	$16,000	$327.68
17	$17,000	$655.36
18	$18,000	$1,310.72
19	$19,000	$2,621.44
20	$20,000	$5,242.88
21	$21,000	$10,485.76
22	$22,000	$20,971.52
23	$23,000	$41,943.04
24	$24,000	$83,886.08
25	$25,000	$167,772.16
26	$26,000	$335,544.32
27	$27,000	$671,088.64
28	$28,000	$1,342,177.28
29	$29,000	$2,684,354.56
30	$30,000	$5,368,709.12

Don’t be disappointed if you had picked the first option. According to the author, most people would have done the same, because our brains are not wired to intuitively understand nonlinear growth.

How does linear growth differ from nonlinear growth?

Linear growth applies to concepts like: calculating the time taken to travel from point A to point B at a given speed, or plotting the growth of a plotted plant. A growth of 3cm per week for a plant is an example of straight-line growth.

While the concept of linear growth is something we are highly familiar with, there are aspects of life where we observe nonlinearity. For instance, the spread of COVID-19 is nonlinear in nature. As we have seen, the number of COVID-19 cases taken on an exponential trajectory at the early onset of virus spread, before tapering off as harsh social distancing measures slow and stifle its spread.

Historically, population growth have also exhibited nonlinear characteristics. Developing nations tend to experience exponential growth in their population until they hit resource, political or cultural constraints. Back in the 1960s, Singapore had to enact a two-child policy as it faced post war food and housing shortages. China’s one-child policy in the 1980s was also similarly designed to control the country’s rapidly growing population back then.

Figure 1: Many nonlinear growth examples take on a logistic growth function; rising exponentially at the beginning, before tapering off due to socio-economic or environmental constraints.

What else takes on a nonlinear form?

Besides the above examples, the wealth of a nation also exhibits similarly to a logistic growth function. While every country has their own unique growth trajectory given the various mix of socio-economic and political factors that come into play, an observable trend is that as a population moves up the wealth ladder, they are likely to experience exponential growth rates.

One reason explaining this phenomena is because at low income levels, disposable income generally rises faster than overall income once basic needs are met. Excess income may therefore be used for discretionary household spending, which may include lifestyle goods and services. When a large number of the population find themselves wealthy enough to afford higher value goods, this opens up new opportunities for growth within the economy.

What are some economies that have undergone this exponential growth trajectory?

South Korea is one of the best examples highlighting the logistic growth path developing economies take as they move up the wealth ladder. The country experienced periods of high growth from 1970s to 1980s as its GDP per capita quadrupled in just 20 years. Beginning from the late 1990s however, its exponential growth has evidently began to slow, as seen from the increasing amount of time it needed to double its per capita GDP after the 2000s.

China also exhibits a similar growth trajectory. Since the 80s, its GDP per capita has expanded close to 30 times – a feat not many countries can claim to replicate within this short time span. While it has enjoyed a longer period of exponential growth that South Korea, recently it is showing signs of slowdown in growth.

Chart 1 & 2: Countries tend to experience exponential growth rates in their early stages of development; time to doubling their per capita GDP decreases during this exponential phase before tapering off

Is India the next China?

There are many similarities that India has with China, with one being its massive population. By 2027, India is expected to overtake China as the world’s most populous nation. It has also one of the youngest population, as seen from its 2020 population pyramid. With a young population, and a rising wealth level, the stage is set for India to grow exponentially over the next decade.

Chart 3: India’s growth appears to be on the cusp of exponential growth

It is unlikely that India will follow the same path China took, in terms of its growth rates, due to large differences in their socio-political and economic structures. However, what we minimally expect is for India’s growth to accelerate as it crosses the critical wealth threshold of 2000 to 4000 USD (in 2010 $US) per year which is the industry accepted income range typically considered as ‘middle class’ (Asian Development Bank, 2010).

UTI Asset Management: An India equity manager with a local DNA

UTI India Dynamic Equity USD an active strategy advised by UTI Asset Management, a home-grown Indian fund manager. The fund was incepted since 15^th July 2015, however, the strategy’s track record goes way back to 27^th Dec 2006 marketed under a different name (Shinsei UTI India Fund).

All of the fund’s investment/research team is based in India. As an equity strategy investing in a less efficient markets, this may present itself as a competitive advantage over its non-India based fund peers, since the analysts/portfolio managers would likely have a better understanding of the services and products of the companies under their coverage.

As an all-cap strategy, the fund may invest across the entire market capitalization spectrum, although the fund only invest up to 30-40% of the fund in mid to small caps. Investment style wise, the fund is largely growth oriented as the fund manager seeks to invest in companies that would benefit from some of the structural growth drivers within India.

Some of the strategic (long term) themes for the fund include consumer related industries and sub-sectors across Banking & Financial Services, Information Technology, Consumer Goods & Services, Healthcare, and Auto & Auto Ancillary. All of these sectors are likely to benefit from long growth runways, as India is expected to add more middle class than any country globally from now until 2050 (Kharas 2017).

How does the fund’s performance stack against its peers and benchmark?

As seen from Chart 4, the fund has been a very strong performer against some of our popular Indian equity strategies, as well as the FSMI and SENSEX Index since the fund’s inception. The fund did not perform well only after the Mar 2020 global equity market meltdown; if you look closer, the fund has consistently stood tall and above other active India equity strategies.

Chart 4: Fund outperforms its peers and the benchmark since its inception

The fund exhibits a higher equity beta compared to others largely rests on its sizeable mid to small cap exposure, which gives the fund an edge during a bull market. Smaller companies tend to have more room to grow than large established companies.

This higher beta exposure, however, is a double edged sword. During periods of uncertainty, the fund has historically exhibited larger drawdowns and downside volatility. There is no exception to the rule; to generate higher returns, investors have to undertake higher risks. What is important is that investors are well compensated for the risk of their capital. Despite its higher downside risk, UTI India Dynamic Equity USD among its peers still has one of the best risk-adjusted metrics on our platform.

Chart 5 & 6: Fund is situated more on the riskier spectrum when compared to our India equity fund universe

Recent COVID worries – danger or opportunity?

Economically, spiking COVID-19 cases may present near to medium term headwinds for the country as India’s full economic reopening will be delayed. It is evident, however, that investors remain buoyant on the long term prospects of India’s economy given the short-lived correction observed in its equity market. 

Chart 7: SENSEX Index barely registers a correction despite exponentially rising COVID-19 cases and deaths

While its COVID-19 mismanagement may prove to be a near term setback for the country, it is unlikely to alter the long term potential of India. India still has the fundamental ingredients to grow quickly given its sizeable young demographic profile. As more young Indians enter the workforce, the country will set to reap its demographic dividends over the next decade.

It is important to note, however, that India has perennially been an expensive market to invest in. As a growth market, investors have been willing to invest in the market at higher valuations over the years. Since 2016, the market has been trading above its 16-year average in terms of its forward 12m estimated earnings (with Mar 2020 as an exception).

Chart 8: India’s equity market still trades at expensive levels going by the forward PE ratio metric

Even after the strong earnings re-rating at the start of the year, the Indian equity market remains in the expensive zone (> 2 standard deviations). Typical value investors, especially those who only like to buy into markets when they are cheap on a forward PE basis, will be hard pressed to find favourable entry points when investing into the Indian equity market. Therefore, we advocate investors to invest via regular savings plan, aligning investors’ investment horizon with the nation’s long term economic potential.

References:

Population Pyramids of the World from 1950 to 2100. PopulationPyramid.net. (n.d.). https://www.populationpyramid.net/india/2020/.

Asian Development Bank, 2010. The Rise Of Asia's Middle Class. https://www.adb.org/sites/default/files/publication/27726/special-chapter-02.pdf.

Kharas, H. (2017, February 28). The unprecedented expansion of the global middle class. Brookings. https://www.brookings.edu/research/the-unprecedented-expansion-of-the-global-middle-class-2/.