One of the advantages of using investment trusts is that if you get the timing right you can benefit from the strong performance of the underlying assets and a narrowing of the discount. These sorts of opportunities don’t come along every day, but long-term investors might find that the India Capital Growth (LON:IGC) fund turns out to be a decent example.
IGC is a £100m fund that mainly invests in mid- and small-cap Indian companies. It was launched in December 2005, but had a disastrous start and got through two different investment managers before the current team headed by David Cornell from Ocean Dial took over in 2010.
It took them some time to recover from the legacy portfolio that they inherited, yet in the last few years they have delivered stronger returns than their better known peers such as JPMorgan India and the New India Investment Trust. Despite this the discount has failed to reflect the improvement in performance and the shares are still languishing 18% below their NAV.
There is no obvious reason why the discount should suddenly tighten, but if the Indian economy continues to grow and the fund is able to maintain its impressive performance record, there is every chance that it will become better known and the demand for the shares will pick up.
The recent elections in India seem to have confirmed the dominance of the ruling BJP party. This appears to have put a stamp of approval on Prime Minister Narendra Modi’s ambitious market friendly reform agenda and should give investors greater confidence that he will be re-elected in 2019.
Ocean Dial thinks that the government will continue with its anti-corruption agenda, which is a policy that has been well received by the vast majority of India’s electorate. The decision towards the end of last year to remove the 500 and 1,000 rupee notes from circulation – to clamp down on the shadow economy – only seems to have had a short-term impact on share prices with the stock market clawing back all of its losses.
Almost 60% of the fund is invested in small companies with a market cap of less than $2bn…
GDP figures for the fourth quarter of 2016 show that the economy grew by 7% year-on-year, which was down from the 7.4% achieved in the third quarter, but well ahead of expectations. Inflation remains within the target range, although Ocean Dial does not expect any near term cut in interest rates and thinks this is encouraging given concerns over the possible impact of a strengthening dollar on the emerging markets.
A recent research report by QuotedData reveals that there are only 37 stocks in the portfolio and that this will gradually be reduced to 34. Almost 60% of the fund is invested in small companies with a market cap of less than $2bn, with 21.5% in the mid-caps ($2bn to $7bn) and the rest in the large-caps along with a small cash balance of 2.6%.
Stocks are selected on a bottom-up basis with the manager looking for companies that can grow and generate high cash returns on capital employed. Ideally they should have at least a six-year track record of generating cash and have returns on equity of 15% to 20%.
The top 10 holdings at the end of February accounted for 39% of the fund with all of them having been in the portfolio for at least three years. In terms of the sectors, the three main exposures were Financials 25.8%, Materials 20.7% and Consumer Discretionary 18.6%.
The companies that are chosen are those that are best placed to benefit from the Indian growth story. They must also have a unique selling proposition that will help to protect their market position; have credible, shareholder friendly management; and pay dividends and taxes.
There are 5,000 companies listed in India, but the manager thinks that only around 400 would be suitable for the fund with the actual holdings restricted to about 10% of this number.
Ocean Dial identify stocks of interest by running screens and then try to visit as many of them as possible with the firm seeing in excess of 300 a year. The focus is on the long-term returns with the manager wanting any investment to at least double in value over three years.
Normally they will avoid sectors where there is a greater risk of corruption such as infrastructure companies. They also tend to steer clear of the listed subsidiaries of multinationals, as these can be slow and bureaucratic, with the manager preferring to use businesses in the same field that are run by people who used to work for the multinationals.
Performance and outlook
Analysis by QuotedData shows that over the five years to the end of February the India Capital Growth share price was up by 113.9%, which was marginally behind its S&P BSE Mid Cap benchmark.
The mid-cap stocks have massively outperformed the large-caps as measured by MSCI India. This is the benchmark used by the other two Indian investment trusts, Aberdeen New India (LON:ANII) and JPMorgan Indian (LON:JII), with both lagging far behind IGC over the last five years.
ANII and JII are much bigger than IGC with market values of around £250m and £730m respectively. They are also cheaper with ongoing charges of 1.3% and 1.22%, and trade on a tighter discount to NAV of around 11%.
Despite the strong performance, IGC currently trades on a discount of 18%, which is close to its average discount measured over the last three years.
Despite the strong performance, IGC currently trades on a discount of 18%, which is close to its average discount measured over the last three years. This seems excessive, but probably reflects the fund’s relatively small size, low profile and the lack of a discount control mechanism.
IGC’s annual management fee of 1.5% is on the high side and when you add in the other mainly flat rate costs the ongoing charges come out at a pricey 1.96%. It is also worth noting that the fund does not use gearing due to the relatively high volatility of the Indian stock market.
The analysts at QuotedData point out that India is one of the fastest-growing major economies in the world and that the fund is deliberately positioned to take advantage of this. IGC is also one of the largest holdings in Nick Greenwood’s Miton Global Opportunities investment trust (LON:MIGO).
Adventurous investors who are willing to accept the inherently high level of risk associated with a £100m single country fund might want to consider a long-term exposure to India Capital Growth. It could work well as a small satellite holding – as could the VinaCapital Vietnam Opportunity fund that I wrote about last week − alongside a core of more conservative positions, but only if you are comfortable with the overall volatility.