Bull run has Indian stock funds topping the charts
NEW YORK - To find the year's best-performing mutual funds, head east.
In India, excitement surrounding a new prime minister has catapulted stocks higher, and mutual funds that focus on the country have reaped the gains. The Matthews India fund (MINDX) has returned 52 percent in 2014 through Wednesday, for example. That's more than any other fund that Morningstar tracks, and it's more than five times the gain of the Standard & Poor's 500 index. Only seven mutual funds have returned more than 30 percent this year, and five of them focus exclusively on Indian stocks.
Nearly all of those big returns have come since the May elections that swept Prime Minister Narendra Modi into power. Hopes are high that the government can push through reforms to invigorate the economy of the world's second-most populous country. India has struggled with high inflation and a slow-moving bureaucracy that has hurt growth, analysts say. Investors have seen some positive changes already, but the most difficult work remains and could take many years to implement.
Most investors are content to keep just a small slice of their portfolios in Indian stocks. Usually, that means owning a general emerging-market stock fund that also includes China, Brazil and other developing economies. But this year's strong returns have lured more dollars to what's historically been a small corner of the market. Investors have plugged a net $2 billion into Indian stock funds this year. The category has just $7 billion in total assets versus $438 billion for general emerging-market funds.
Those investors should keep in mind that Indian stocks have historically seen sharper swings than U.S. stocks, says Sunil Asnani, lead portfolio manager of the Matthews India fund. He's optimistic that Indian stocks can keep rising in the long term, but anyone looking to make money in the next year may be disappointed. Here are excerpts from a recent conversation. Answers have been edited for length and clarity.
Q: How much of this year's gains for Indian stocks are due solely to Modi's election?
A: If you look at the fundamentals of companies that were doing fine before the elections, they haven't gotten dramatically better. And the fundamentals of companies that were not doing well before he came into office haven't become better either. My conclusion is this rally has been driven primarily by the Modi wave and the sentiment of what Mr. Modi can do.
Q: Have any big reforms actually gone through yet?
A: The big-bang reforms -- labor, land, agriculture -- they are still not coming. I don't expect these to happen overnight. If they're able to achieve 50 percent of them in the next few years, that will be a good achievement.
Q: Are you worried then that the market's expectations are too high?
A: In India's case, they are never realistic. Maybe they are expecting too much, especially on companies where their valuation is hinged on reforms taking place. There, they will see a lot of disappointment.
Q: So is it foolish to get into an Indian stock fund now? Wouldn't that just be buying high?
A: If you look at the valuations of stocks, they are slightly above their historical five- and seven-year averages. So if you're making a shorter-term investment, they can go in either direction.
But if you take a longer-term view, then you might see returns aligned with earnings growth for the companies. And if you look at the earnings growth, that hasn't changed a lot. Nominal growth of the economy easily should be between 10 percent and 15 percent each year, with real growth of 5 to 7 percent and inflation on top of that. So, with a longer-term view, it's an easier call. In the next 12 month, it's very hard to say.
Q: You were a police superintendent in India and may have a better view on this than others: How worried should investors be about the quality of accounting and corporate governance at Indian companies?
A: I would quote an investor -- his name is Rob Arnott -- and he says what is comfortable in investing is rarely profitable. You will find a lot of companies with bad accounting standards in India. But at the same time, you will be able to find well-run companies and good entrepreneurs who are trying to navigate through the complex system of bureaucracy and the demographics of India. If you find them and stay with them in the long run, you should be fine.
Q: What misconceptions do investors have about Indian stocks?
A: People consider investing in India for diversification. Now, diversification means different things for different people.
When there's a crisis in the developed markets, a person looking for diversification is hoping their investment will be safe in India. But it is quite the opposite. (In 2008, the average Indian stock fund lost 64 percent versus a 37 percent loss for the S&P 500). When there is a correction in the United States, there is a bigger correction in India, so the Indian market doesn't provide any diversification in the short term. If you're looking for long-term differentiated returns, then you will see India doing better than developed markets.
Q: Why are Indian stocks more volatile than the U.S. market?
A: Because it is dominated by foreign investors, both in ownership and trading. So it will remain volatile, but the underlying earnings growth is less volatile.