India: what the new economy transition means for investors
India: what the new economy transition means for investors
The size, growth, and promise of India’s economy are no secret to investors. How this translates into equity market opportunities is an area which has garnered less focus, however. At least not in the same way that global investors might talk about companies such as China’s Alibaba or South Korea’s Samsung Electronics. This may be set to change.
Earlier this year we discussed how the Covid-19 pandemic has accelerated the digital revolution in India. The transition to a more organised way of doing business, underpinned by a series of reforms, is underway. The two primary drivers of this change are the unique biometric identification system, known as Aadhaar, and the high penetration of telecoms in the country.
In equity market terms, we are seeing this digital transformation metamorphosise in different forms. Incumbent, old economy, companies are adapting their business models for the new digital world. Meanwhile new economy companies, with innovative products and services, are taking market share, or carving out new markets.
This disruption to the status quo will create future equity market leaders, with implications for market and index composition. Indeed, as we explain, many of these new economy companies were until recently not available in pubic equity markets. These companies are now arriving, with new listings attracting new capital, both domestic and foreign. These are exciting times in Indian equities.
How the transformation is taking place
Old economy companies are adapting
Large incumbent companies are changing their business strategies. Reliance Industries, for example, an energy, telecoms and retail conglomerate, and the largest weight in MSCI India Index, went on a massive deleveraging drive by selling stakes in its telecom venture Jio and its retail business. The company raised more than $30 billion in less than a year. Reliance runs the largest oil refinery in India and has announced plans to reach net zero carbon emissions by 2035, as well as invest in green energy. Meanwhile, Tata Motors, owner of Jaguar Land Rover, has launched electric passenger vehicles (EVs), capturing a large market share within India.
New economy companies are listing
There has been a surge in capital raising by Indian companies over the last three years, both in terms of primary and secondary issuance. 2021 has seen some large initial public offerings (IPOs) in the market. Total issuance has amounted to INR1.7 trillion, equivalent to around $22.6 billion, of which IPOs are INR713 billion.
This scale of IPO this year is second only to 2017, when three large state owned insurance companies listed on public markets. Some of this year’s IPO’s are new economy business models which were previously not listed in India, or do not have many similar listed competitors. The food discovery and delivery company, Zomato; online vehicle dealership company Cartrade Tech; infrastructure investment units from PowerGrid and environment friendly chemical producer Clean Sciences and Technology are examples of the changing landscape of the Indian markets.
Underlying these changes is the question over the future market dynamic. Who will be the winners and losers, will there be multiple players in each sector or category, or will one existing or new company become dominant in the way that Amazon has in the US for example? It’s too early to answer these questions, but the fact that these businesses are becoming available in India’s public markets is clearly positive.
How the new economy has grown in significance
Private equity and venture capital interest in India has also been growing at a rapid pace over the last few years, attracted by a mixture of existing companies, and newly founded start-ups.
As a result, an array of “unicorns”, companies which are valued at $1 billion or more, have been minted. And these private equity and venture capital investors are now increasingly taking the IPO route to exit their investments.
Regulatory changes have also been an important catalyst in enticing these companies to public markets. The Innovators Growth Platform (IGP) is a regulated platform which enables fledgling, high-growth companies to list on public markets. It was founded as the Institutional Trading Platform back in 2015. The IGP is an ecosystem which can be thought of as a very early stage NASDAQ type platform.
The Securities and Exchange Board of India (SEBI) recently moved to relax some listing requirements, streamlining the process for companies to come to market on the IGP. For example, the minimum holding period for investors was reduced from two years to one year.
There is now a long pipeline of companies expected to be listed in the coming 12-24 months, based on the IPO prospectus filings and company announcements. The estimated new market capitalisation to be added in the next three years could touch $400 billion according to some recent reports.
Some of these companies have large market caps and have a high amount of liquidity given the demand for new economy businesses. This may mean a large shift in index composition and weights in domestic and international indices. This could also see some increase in India’s weight in global indices.
What is the significance of these changes for markets?
India is currently the world’s seventh largest equity market by capitalisation. If the pipeline of listings comes through as described above, India’s equity market capitalisation could cross $5 trillion by 2025, lifting it into the top 5 globally.
The size of the India’s equity market has been growing at a faster pace than ever before. From a $1 trillion market cap in 2007 to $2 trillion in 2017, it now stands at $3.5 trillion. The jump to $5 trillion by 2025 would be the fastest ever gain for India. From an investor perspective, this should have welcome positive impacts in terms of the level of market interest, liquidity, and average daily traded volumes.
Global allocations also depend on the country’s weight in global indices. As with other emerging markets, India’s economic might is not reflected in global market indices. While India’s share of global GDP is almost 3.5%, its weight in the MSCI All Country World Index is only 1.4%. This has potential to increase, with GDP widely expected to continue to grow at over 6% for the next few years, increased aggregate profitability of the markets from the new listings, and improved liquidity. The increase in weights in global indices would mean a large inflow of passively managed investments in addition to actively managed funds.
This trend is similar to that seen in other emerging markets like China. For example, in China, the weight of the internet sector (including media, software and e-commerce companies) increased from zero in the early 2000s to more than 50% in 2021. Approaching this from a new economy perspective, as opposed through sector classifications, emphasises the potential importance of these companies in market terms. e-commerce companies Alibaba and Pinduoduo, internet names Tencent and Baidu, together with food delivery business Meituan, EV company NIO and Wuxi Biologics have a combined weight of almost 35% in the MSCI China Index.
India’s equity market indices have not changed significantly in the last ten or even twenty years. The companies which plan to list and the unicorns have significantly larger market capitalisation and free float when compared to the existing index constituents. For example, Zomato would rank as the 50th largest company by market cap at $13.3 billion.
What do valuations look like?
Indian equities for the market as a whole are not cheap, as the chart below illustrates. This is partly cyclical, in that Indian stocks typically outperform other emerging markets at this point in the economic cycle. But there has also been a longer term shift in valuations as reforms have enabled the mobilisation of domestic capital, spurring strong retail investor flows.
Retail interest in domestic mutual funds continues to be strong, as it has been since late 2016 post demonetisation – when several bank notes were removed from circulation and replaced - as the economy becomes more formal. Low interest rates and near zero returns in physical assets like gold and real estate has ensured that most of these savings are channelled to equity markets. The equity assets under management of the industry have more than doubled in the last five years.
A sharp upwards move in equities since March 2020 has meant more retail investors trying to gain out of direct investments as well. A centralised know-your-customer applicable to securities markets has helped to open accounts faster in a digital format. Strong domestic demand for equities coupled with foreign inflows in a benign global interest rate scenario has resulted in demand matching supply of securities at higher valuations.
Indeed, aggregate market valuations could yet rise further. This is because many of the unicorns coming to market are still have negative earnings, and as digital companies are highly valued.
Historically, Indian equities have traded at a premium to other large emerging markets, as well as broader MSCI Emerging Markets Index, and continue to do so. One of the main reasons for the higher valuation is a better growth profile of the Indian corporate sector.
With the listing of the large digital focused companies and their inclusion in indices over time, earnings growth estimates are expected to increase further. This, along with a strong preference for the theme, may lead to substantial demand from domestic and international investors. No one can predict the future but going by past history, India may continue to enjoy premium valuations compared to other emerging markets.
What does this mean for investors?
The changing landscape of India’s equity markets will have implications and opportunities for investors. The most recent rally in Indian markets has mainly been driven by strong earnings results during the pandemic, and the re-opening of the economy. Global liquidity has also played a big role in the current performance. With the new listings, the optimism continues with a medium to long term view.
Quite a few of the large, old economy, stocks are now showing growth in excess of broader economic growth. The ability of the new companies to grow at break neck speed has increased the thematic appeal for such business models.
While private equity and venture capital investors have participated early in these ventures, public market investors will also get a chance to participate in this growth story. Quite a few of the listings in the last few years have performed very well post-listing.
The new economy sectors in India could offer attractive return opportunities, however there is no guarantee of this. We believe the key in searching for opportunities is to maintain an active approach, and to be selective in order to avoid overpaying for growth.