July 2009

INDIA: the inside story

India is still growing and there are many reasons to be confident its economy will continue to develop. Fiona Rintoul finds that the country’s internally driven market is a great strength, but makes things tough for foreign players elephant.jpgAlthough economic growth in India has slowed to 6-7% over the past year after reaching a record 9% in the four previous years and jobs have been lost as a result of the recession in the West, people are still finding plenty of reasons to be optimistic about the world’s largest democracy, particularly in the wake of the recent elections which delivered a decisive victory to the Congress Party rather than a feared inconclusive result. Certainly, Prime Minister Manmohan Singh and his government have their work cut out. In his acceptance speech, Mr Singh said his main challenges were to revive the economy, create jobs and ensure that the benefits of growth reached the underprivileged – not a small list – but there are many positives to buoy the mood.

In a recent presentation, Alroy Lobo, chief strategist and global head of equities at Kotak Mahindra Group, India’s fourth largest private bank and one of its leading financial services groups, outlined some of them. They included the new “strong and stable government”, India’s strong macro positioning and a solid demand story dominated by domestic factors, the country’s powerful demographics, and its sound banking system compared to peers.

The fact that India’s economic growth story is more internally driven than that of other emerging markets is a key strength highlighted by many analysts and emerging markets fund managers. Interestingly, this strength is reflected in the country’s fund management industry, which is dominated by Indian players, with nine out of the top ten players being a national firm that most people outside of India will never have heard of.

“Foreign funds currently have a low market share in the Indian fund industry,” says Shridar Iyer, CEO of Sundaram BNP Paribas Fund Services.

Keeping it local
The total assets under management (AuM) for foreign funds is around Rs0.4 trillion (€5.9bn), he says, against a total market size of Rs6 trillion. Some of the foreign players have chosen to participate in the industry through joint ventures with majority shareholdings, these account for another Rs0.26 trillion of AuM.

In many ways, India is reminiscent of the Russian market. Western brands don’t cut too much ice.  “Global brands are now in the top eight to ten cities, but not beyond,” says Nikhil Johri, managing director of Fortis Investment Management India. “The big Indian brands are known in more than 100 cities.” And Western firms have perhaps overestimated the advantages they might have in the fledgling market.

“In the first few years, there was still a belief that global asset managers in India would have a lot of technological advantages,” says Johri. “But over the last few years that gap has been minimised. There has not been a big differentiation.”

Foreign managers who came to the market in the 1990s in the initial stages, many of them US firms, often didn’t have the requisite patience, adds Johri. Now there is a new wave – companies such as Fortis, BNP Paribas, DWS, BlackRock and Morgan Stanley – that seem to be more patient.

One of the challenges for these companies is that they can’t sell international funds in India. It’s all local-to-local business and they have to find a way to succeed in that arena. Often they are up against national players that belong to a financial services group with distribution in 100-200 cities across India.

That’s why a company such as Fortis sticks to servicing wealthy clients who it can target through private banks. In addition to local products, it has been able to sell these clients a ‘Chindia’ fund investing in China and India, since certain master-feeder structures were permitted by the Indian authorities a couple of years ago. Under this arrangement, the India part of the fund is managed locally and the China part from Fortis’ offices in Hong Kong.

In any case, most investors are, as yet, little interested in international investment.

“Indian investors believe the Indian stock market will be the best performer,” says Johri. “It’s very difficult to persuade them to invest in a Latin American fund.”

Despite the restrictions and difficulties in competing, many global asset management companies are attracted to India. That’s partly because there’s a growing middle class, growing wealth and a growing need for investment as investors move away from real assets such as gold, says Jacqueline Alhous, head of offshore research at OBSR.

This expansion stands in contrast to the stagnation experienced in many developed markets. “With global markets flattening
out, it is expected that more global players will turn their attention to Indian markets,” says Iyer.

There are also signs of wealth in India spreading beyond the middle classes. Various measures have been taken to promote wealth in the agricultural parts of the country, says Aldhous. “When you look at growing wealth you take it for granted that there’s an expanding middle class, but the government is also keen to spread out wealth. There’s been a loan waiver for farmers, for example, and a 100-day employment scheme.”

At the same time, there are the beginnings of a pensions industry.

“The process of setting up the pension regulatory authority is an important step forward,” says Iyer. “Earlier, the new pension scheme announced by the government was applicable only to government employees. However, now it has been opened up for all citizens of the country. Further appointments of private sector fund managers to manage these funds is also seen as an important step forward.”

Targeting rural investors is probably for the future, though. Johri says that main task for now is to persuade those who save through bank accounts to look at funds and to expand the investors base from the eight to ten largest cities to the next 100-200 cities. At the moment, 85% of money flows in through top 10-12 cities in the country, according to Iyer.

Companies that can achieve distribution in a wider range of cities have more stable flows, according to Johri. This helps somewhat with the problem of ‘flipping’. Many investors are encouraged by advisers to flip, says Alhous. One of the reasons why there are so many closed-end funds in the market is to try and combat that.

“They try to engender loyalty,” says Aldhous.

The distribution dilemma
Part of the challenge in expanding out of those ten main cities, even for national players, is distribution – and it will become an even bigger challenge if and when investors in rural areas can be brought on board. Like Russia, India is a huge country and covering it is a massive task. And there are, says Johri, many Indias.

The cost of distribution is thus high and Iyer cites this as a key negative for global players. “Reduced margins could act as a deterrent,” he says. “With increased distribution costs and reduced investment fees, margins are likely to be under pressure.”
The good news is that distribution is fairly open. “Banks are the key distribution channel followed by national distributors and IFAs,” says Iyer. “There is also around 10% of AuM that is received directly from investors.”

The AuM that is received directly from investors sometimes comes through offices like bank branches, says Aldhous, who was amazed to see a Gartmore ‘counter’ in a major Indian city.

“People go in and do their fund bits and pieces,” she says.

As for bank distribution, unlike in many European markets, the Indian banks have embraced open architecture pretty much from the off.

“There is a fair bit of open architecture,” says Johri. “It’s a big source of revenue for those distribution houses. And because we started late in terms of the global market, a lot of things happened quickly. People are often surprised to see how well developed the market is.”

The bad news is that advisers are not regulated and are of variable quality.

“Only the top end go through a rigorous education,” says Johri, who is thinking of cutting back his field of advisers from 3,000 to 1,000. “Most asset managers spend a lot of time and effort on training their own set of advisers.”

The truth is that India has great potential as a market for investment products, but is in the very early stages of development. At the moment, it’s a question of growing the basic industry, which comprises largely equity, fixed income and money market funds invested locally.

Global players have brought some innovation to the market – commodity funds, structured products, a very limited number of products that invest overseas – and there is no doubt room for more of that.

Commentators suggest that the basic industry will need to reach a certain size before it is ready for the next stage. The time scale most commonly cited is five years. By that time, the industry should have grown to around Rs15 trillion (€222.5bn), says Iyer.

But, as always with new markets, there may be prizes for those that get in early, not just because that shows a commitment to the market and allows the important process of brand building to begin, but also because it is not known if the market will remain as open as it is now.

“Right now it’s all open,” says Johri. “Any asset manager who meets the minimum track record can set up. In a few years time it may not be so easy. The government may decide there are enough companies. That’s why we have seen various global players entering the market over the past five to six years. A number of players have come in with a long-term view.”

©2009 funds europe

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