Ellerston India (ECL0339AU) Report & Performance

The Ellerston India Fund (EIF) was up 1.8% (net) in July versus the MSCI India Index (MXIN) which was up 1.7%.

As highlighted in the performance summary table, the accrual of taxes continue to have a material impact on portfolio performance. We note that during the month, we recognized a positive adjustment in the tax accrued by the fund, which led there to be a minimal net tax impact in the July numbers.

The Indian market was buoyed by risk-on sentiment globally, driven by further evidence of moderating inflation, and better than expected earnings out of the US. This led to foreign institutional investors (Fils) purchasing an additional US$3bn of Indian equities over the month. So far in 2023, Fils have injected ~US$16bn of capital into the Indian market, which would make it the strongest start to a calendar year in over a decade. Not to be outdone, domestic investors put US$0.9bn of liquidity into the Indian market in July and have been net buyers in six of the past seven months.

India has been one of the best performing markets in Asia in 2023, with the MXIN up 6.9% in local currency terms. Investors have appreciated the stability offered by India’s growth story and the supportive policy setting environment. Indeed over the past month, the Reserve Bank of India (RBI) kept policy rates on hold at 6.5% for a third successive meeting whilst maintaining its FY24 GDP growth forecast of 6.5%. Although inflation moved up to 7.4% in July, due to a sudden rise in food prices, the RBI has signaled an intention to ‘look-through temporary price shocks and continues to forecast FY24 CPI (of 5.4%) to be within its 2-6% target range. Furthermore on growth, the IMF recently upgraded Indio’s 2023 growth target to 6.1% (vs 5.9% previously) citing the robust domestic investment environment. High frequency data meanwhile remains positive, with PMI (61.9 in July) and vehicle registrations (+10% yoy in July), confirming a solid demand environment. Within EIF, we are positioned in sectors such as financials (HDFC Bank, ICICI Bank), consumer (Varun Beverages, Maruti Suzuki, Phoenix Mills), healthcare (Max Health) and industrials (ABB India), which are leveraged to India’s domestic demand and infrastructure buildout stories. Conversely, we are underweight offshore earners such as IT services.

An interesting development in the Indian market during the month was the formal completion of the merger between HDFC Bank and HDFC. HDFC Bank now becomes a financial behemoth with a US$150bn market cap, making it the 7th largest lender in the world. Despite its size, we believe the merger can still add significant shareholder value over the next few years given the potential synergies. For instance, the merger will allow HDFC Bank to combine its relatively lower cost of fundingwith HDFC’s leading mortgage book to offer more competitive personal loan products. The merger will also provide significant cross selling opportunities, given 70% of HDFC customers currently do not bank with HDFC Bank. These factors, along with structural tailwinds from rising disposable income and increasing penetration of financial services across India, should drive high quality double digit earnings growth. ROE is also likely to improve over time from the current -15% (pro forma) levels. Valuations meanwhile look reasonable at 2.2x P/B and 17x PE. HDFC bank remains one of the largest and core holdings in our portfolio: Activate Windows

July also saw the start of the June quarter reporting season and thus far, results have come in broadly in line. Earnings forecast have been cut by -0.5% with weak tech results offset by strength from domestic cyclicals leveraged to the capex upcycle, and financials. Consensus continues to forecast 12 month forward earnings growth of ~18% yoy vs forward PE of -20x.

The Ellerston Indio Fund (EIF) was up1.4% (net) in June versus the MSCI India Net Return Index (AUD)which was up 1.8%.

The Indian market continued to grind higher, driven by strong foreign inflows and robust economic data. Indeed, foreign institutional investors (RI) were net buyers of another USS8bn of equities in June. Over the post three months, Flls have poured USS15bn d liquidity into the Indian market, which is the strongest quarter of inflows in 3 years.

On the economic front, high frequency indicators such as PM! (59.4 in June), credit growth (+14% YoY in June)and vehicle registrations (+10% YoY in June) remain healthy. Meanwhile, India’s current =aunt deficit (CAD) narrowed significantly to 0.2% of GDP in 4QFY23. This is the lowest in 2 years and was helped by an improved trade balance and positive setvicetilths exports. Finally, the latest inflation reading ca me in at 4.8% and comfortably within the Reserve Bank of India’s (RBI) 2-6% target range. This should allow the RBI to keep rates on hold at 6.5% for the foreseeable future. A more benign inflation outlookond interest rate stability provides o less volatile backdrop for investors into India.

Another positive development during the month was the decision by the Indian government to hike the Minimum Support Prices (MSP) for Kharif crops (monsoon or autumn crops) by 7.8% YoY for FY24. This MSP hike was the second highest increase since FY14 and the largest in 5 years. An increase in the MSP is likely to improve rural demand for autos, industrials (piping), materials (cement) and theconsumer staples categoric. We see this policy as part of Prime Minister Modi’s populist agenda ahead of the general elections next year. The Government has already handed down o pro-cyclical budget for FY24 where capex was forecast to increase by 18% YoY. We expect further supportive policies to be announced in the coming months. This again should be positive for Indian equities.

We remain cautiously optimistic on the Indian market in the near term with a forward PE of 20x, backed up by forecast earnings growth of —19%. The EIF portfolio is currently skewed towards financials, consumer, healthcare and industrial sectors which provide exposure to India’s domestic demand and infrastructure buildout stories. The portfolio is also holding —’8% cash providing dry powder to take advantage of opportunities incase of a pull back.

The Ellerston India Fund (EIF) was up 4.2% (net) in May versus the MSCI India Index (MXIN) which was up 5.1%.
This was the third consecutive up month for the Indian market and was driven by the release of positive economic data and the conclusion of a solid 4QFY23 reporting season.

On the economic front, India reported 4QFY23 GDP growth (+6.1%yoy) that was significantly ahead of market expectation of —5-5.5%. This meant that India achieved GDP growth of 7.2% in FY23, which ranked amongst the fastest of any major economy in the world. inflation meanwhile came in at a 25-month low of 4.25% in May. With inflation having peaked and now comfortably within the Reserve Bank of India’s 2-6% target, this allows the central bank to keep rates on hold for some time barring a sharp uptick in global inflationary pressures. This therefore creates an ideal backdrop for India to continue achieving global leading economic growth in FY24.

May also saw the end of Q4FY23 earnings season, with corporate India recording revenue and earnings growth of +14%yoy and +20%yoy respectively. The positive operating leverage exhibited by corporates was driven by more benign costs environment. Consumer Discretionary, Communication Services, Healthcare and Financials were the standout sectors from a growth and earnings revision, while Materials and Information Technology were the weakest. EIF portfolio companies performed commendably with the majority beating or in-line with market expectations. The portfolio companies recorded median revenue and earnings growth of +18%yoy and +21%yoy respectively in 4QFY23.

The positive read-throughs from recent economic data and corporate earnings have driven renewed interest in India as an investment destination. Indeed during the month, foreign institution investors (FII) purchased US$5.4bn of Indian equities, whilst domestic mutual funds returned to being net buyers. India is forecast to record GDP and earnings growth of +6.5%yoy and +20%yoy respectively in FY24. This is likely to look increasingly attractive in a world where growth is becoming scarcer and we believe further inflows into the Indian market is likely. The only pushback on the India investment story is the valuations with the MSCI India trading on —20x forward PE. This leaves little room for error for many Indian corporates. As such, we are taking a cautious approach to investing in India and prefer high quality companies across the financials (HDFC Bank, ICICI Bank), consumer (Varun Beverages, Maruti Suzuki), healthcare (Max Health) and Industrial (ABB India) sectors that provide exposure to India’s domestic demand and infrastructure buildout story.

Finally, in an interesting development for the month, the Indian government announced withdrawal of INR2000 notes from circulation on 19th May. This is the largest currency note in circulation and was introduced in Nov 2016 a part of the demonetization program. The note will remain a legal tender and can be exchanged or deposited in bank accounts until September 30, 2023. Based on what we’ve seen post demonetization in 2016, the liquidity from this note removal could eventually find its way into mutual funds and the domestic equity market in the coming months.

Financials and Communication Services were the largest contributors to alpha during the month. Whilst, Information Technology and Industrials were the largest detractors. At company level, Tata Motors, State Bank of India (SBI) and Phoenix Mills were the key alpha contributors. Tata Motors is benefiting from a stronger product cycle in India with many of its passenger vehicle (PV) and electric vehicle (EV) models gaining good traction.

The company saw PV volumes accelerate to +14%YoY during April. Further, the market was enthused by Jaguar Land Rover’s commitment during the month to invest GBP15bn into its EV program over the next five years. The SBI share price has recovered following concerns about its exposure to the Adani group of companies, which appear overplayed. The company has disclosed that that Adani related exposure is ~0.9% of its total loan book and backed by cash generating assets. Meanwhile, SBI has exhibited steady improvements in its core metrics including NIMs, cost structures and ROA/ROE. Finally, Phoenix Mills was boosted during the month by the surprise decision from the RBI to keep the repo rate on hold. The share price was also boosted by a favourable broker initiation which highlighted the company’s high quality destination mall portfolio, expansion opportunities and strong balance sheet.

Infosys, Tech Mahindra and Hindustan Unilever were the key detractors for April. Both Infosys and Tech Mahindra reported softer than expected 4QFY23 results due to project delays/cancellations and muted new deal wins. Forward guidance was also below expectations with Infosys expecting only 4-7% topline growth in FY24 due to uncertainty in the customer demand outlook, particularly in North America. As a result of these disappointing results, we believe there are better opportunities in companies with greater exposure to India’s domestic demand story. As such, we exited Tech Mahindra during the month and reduced our position in Infosys.

Hindustan Unilever also reported a subdued 4QFY23 result with revenues and earnings growing 11% and 10% respectively. Management however provided constructive outlook commentary with demand recovery and margin tailwinds from lower raw material costs to provide tailwinds for earnings in upcoming quarters.

The Ellerston India Fund (EIF) was up 0.81% (net) in March versus the MSCI India Index (MXIN) which was up 1.85%. For the March 2023 quarter, EIF was down 2.4% compared the MXIN which was down 5.2%.
March was a volatile month for Indian equities with the banking turmoil in the US and Europe and concerns over global contagion risk weighing on returns early in the month. This was followed by a strong rebound after measures to stabilise the financial sector were announced. The domestic market was also helped by a recovery in Adani related stocks following reports of an investment by a prominent overseas investor.
The Indian market has retraced by HO% from the peak in December 2022 and has underperformed most global indices in 2023. We however continue to view the recent correction as a healthy pullback given the market’s relative outperformance in 2022 and previously elevated valuations.

The positive domestic demand story meanwhile, remains intact as evidenced by recent PMI (manufacturing 56.4, services 57.8), credit growth (+16%YoY), housing (property sales +14%YoY from Jan-Mar) and consumption (vehicles sales +14%YoY) data. Furthermore, the stabilization in oil prices in 2023 have alleviated near term inflationary pressures. Indeed, the latest CPI reading of 5.66% is back within the Reserve Bank of India’s (RBI) 2-6% target band and the central bank has projected inflation to fall further to 5.1% in 1QFY24. The improving outlook for inflation has allowed the RBI to turn incrementally less restrictive by keeping the policy rate on hold at 6.5%. Robust domestic demand coupled with a less hawkish monetary policy outlook provides a more favourable backdrop to achieve the RBI’s GDP growth forecast of 6.5% in FY24, which would make India the fastest growing major economy in the world over the next 12 months.

On the external risks presented by the recent collapse of Silicon Valley Bank, Silvergate Capital and Signature Bank in the US, we see limited impact to Indian banks. Domestic banks such ICICI Bank and HDFC Bank have more diversified and less risky liability and asset exposures than their US peers. Further, Indian banks are bound by much stricter regulations around capital and liquidity and regulators provide more comprehensive deposit insurance coverage than their overseas counterparts. As such, we see any contagion risk from the banking turmoil overseas as manageable.

The recent correction in Indian equities has seen valuations move back to a more reasonable level with the MXIN trading at 19x forward PE. This looks inexpensive compared to earnings growth for the Indian market of 19% over the next 12 months. We have therefore used the recent market weakness as an opportunity to increase exposure to high quality companies in the consumer and industrials sectors.

The Ellerston India Fund (EIF) was up 0.7% (net after tax) in February versus the MSCI India Index (MXIN) which was down 0.3%. Indian market stayed weak through February reverberating under the Adani Group companies’ sell-down that started in January. Foreign Institutional Investors remained net sellers of A$1bn whereas domestic investors deployed their cash reserves buying A$3.5bn into the market weakness. Retail equity inflows in February were one of the highest seen in recent months, as local investors stay buyers at dips. The underlying Indian economy is still chugging along well with 4.4% GDP growth in the October-December quarter, in-line with Reserve Bank of India (RBI) and market expectations. GST collection had another good month up 12% YoY. Government Capex has also been strong growing at 60% YoY over April to January FY22 with greater emphasis on roads, railways, and water resources. In its February meeting, RBI raised repo rate by another 25bps increasing the repo rate to 6.5%, a total of 250bps increase since May 2022. February CPI is still high at 6.4% though in-line with market expectations but above the RBI tolerance band. Market expectations are of another 1 or 2 rates hikes of 25bps before RBI takes a pause. The recently ended third quarter (October-December) results season was solid with 20% adjusted earnings growth. Financials had a stellar quarter with decadal-high NIMs and decadal-low credit costs leading to robust ROAs. The consumer sector did have some weakness with a mix of factors (pent-up demand normalizing, inflation, seasonality) hurting demand but margins were strong as RM costs deflated. We expect the slowdown in discretionary demand to be a short cycle and expect headwinds to get absorbed in coming quarters. IT/ITES sector reported a decent quarter with in-line US Dollar revenue growth but surprised positively on operating margins as attrition and subcontracting trends came in better than expected. Domestic cyclicals like Cement, autos and cap goods also reported strong results primarily benefiting from improved margins.