Thank you everyone for joining us this evening. And I'm given to understand many of you are investors in the India Trust or the Emerging Market Trust, so special thanks to you all. And thank you to AJ Bell for organizing this. So we have about 30 minutes, and I'm told you're very interactive, so I'm going to leave 10 minutes for Q&A at the end. In the previous 20 minutes, I'll cover half the time on the fund itself, the trust itself, and about half the time on the Indian story or the Indian macro environment.
So as you may be familiar, the fund has delivered strong performance over the last six-plus years. To generate performance sustainably, in terms of consistently and over a long period of time, it's my belief that it's crucial to have a strong, focused investment culture. Now this is a slide I put together about 18 years ago, and it's pretty much the same today itself. The four key elements of that performance-first culture are the philosophy, the team, process, and portfolio construction, which have to be aligned together.
Now, without going into details of this on this forum, think of it as having a — at the core of it is having a sports team or a sports person-like drive to win the gold medal or the World Cup, if it's cricket, yeah, and rather than the typical mindset that pervades the industry and is the bane of the industry of being above average or top quartile. No sports person, when they were competing or when they were pursuing, let's say as a teenager, the sport, aimed to be a top quartile marathon runner or a top quartile 100-meter sprinter. This top quartile would mean 25% of your neighborhood is running 100 meters faster than you, yeah.
If you were to compete in the Olympics, or if you were aiming to compete in the Olympics as a teenager should, if they're pursuing that as a lifetime pursuit, you must aim to run 100 meters in less than 9 seconds, beat the world record, and win the gold medal. That doesn't guarantee your success, but at least your starting point, the goal setting, has to be correct. And that's where, personally, if you ask me, my strength lies in building teams where I can establish this drive, this performance-first drive, yeah. And everything we do is an element of that.
And these four crucial aspects, you have to get it right and sustain them through time, day in, day out. So on the team, we have a 45-member team. In my view, to keep it short, it is the most well-resourced team of the best stock pickers, in my biased opinion, in the industry. Yeah, very seasoned, extensive investing experience, not only in India but across emerging and developed world, and a unique team-within-team structure. All-star team. In cricket, you are limited to 11 members. No reason to do so in investing. More members are not necessarily better and doesn't guarantee success, but yes, it would be helpful if you can have, you know, dozens of batsmen rather than just 11 of very high caliber when you're scoring runs.
The shared philosophy of the team is that outsized returns are earned over time by investing in great businesses at attractive valuations. So I'm sure most managers that you've heard say something similar in one form or another. So the devil lies in details and execution. You know, we all know that to have a healthy body you must eat well, sleep well, exercise, and have a stress-free life, but very few of us can execute that day in, day out throughout the year. So the devil lies in execution. What sets the team apart is execution of the process day in, day out, 365 days, year after year.
What we believe makes a great business: one that has these attributes — superior returns on incremental capital, scalable opportunity, and a strong execution DNA of the management. Above all, adequate governance, because in the absence of governance it may be a great business for the controlling shareholder, not for minority shareholders. And these are born out of the fundamental first principles of valuation, where the value of any business is the present value of future cash flows. So cash flow is only possible over the long term, sustainably, if returns on incremental capital, forward capital, are higher than the cost of capital. Scalability is about the G in the denominator, and when you have the potential for these two, you need execution DNA to deliver on those, and above all, governance DNA, so that those cash flows would be shared with minority shareholders in fair proportion.
Yeah, when we find, in any given year, our team has over 3,000 company interactions — not just company interactions, but includes the players in the ecosystem, so suppliers, distributors, ex-employees, consultants, regulators, so on and so forth — when they identify companies with such characteristics, it's important to then value them logically and invest only if and as long as there's substantial upside to fair value. Otherwise, as you must have oftentimes heard, a great company does not necessarily make a great investment.
We are also not from the school of thought that buy and hold, buy at any price and hold forever a great company. Maybe such approach has some merit in delivering above-average returns, just above the benchmark. But as I said earlier, the goal is not just to beat the benchmark, but to beat the best-performing manager out there. And to that end, valuation discipline is very important in adding those incremental few percentage points of return that make all the difference. Having said that, we don't use P/E multiple or EBITDA multiple or such multiples — they're very misleading. And what we instead focus on is first-principles-based cash flow analysis.
Adapted to our philosophy, in which any company — let's take for example very quickly GlaxoSmithKline — would be split into FinCo and OpCo, where FinCo would have the plant and machinery and working capital. The OpCo would pay the cost of using plant, machinery, and working capital, and after paying taxes, what is left is excess return on invested capital, which is this top point here. And the present value of these excess cash flows, value of excess ROIC in the business, as the value of this company is just the value of the invested capital. So we split the enterprise value into its two distinct components, and then when you rearrange the terms, you also get what is price-to-XSR multiple rather than P/E multiple.
Price-to-XSC multiple provides you more apples-to-apples comparison because it normalizes for capital intensity of the business as well as capital structure of the balance sheet, neither of which is done with P/E multiples. And that's why P/E multiples can often lead to apples-to-lemons kind of comparison.
India provides a very favorable, very fertile hunting ground. We have over 800 companies with market cap of $550 billion, which is about half a billion pounds. So a large number of small and mid-cap companies, which are obviously an inefficient segment of the market. Obviously, just simply investing in small and mid-caps doesn't make you earn high returns, but if you combine that with a strong management team and an appropriate research process, fundamental research process, and proper risk management, then it can do wonders.
Governance, you know, very important. As I said, we categorize into five different forms of misgovernance: cheating existing partners, meaning siphoning of cash or value; cheating investors at large, stock price manipulation; unethical or illegal business conduct. So these are like the, you know, conglomerates — think of, you know, in yesteryears, Samsungs in Korea or Rockefellers in the US, and won't mention any of the British or European names, but you all probably have read those stories. Misaligned interests or objectives, SOEs, government-owned institutions, and so on and so forth.
Portfolio. So I've covered very briefly team, philosophy, process. Just to touch on very important portfolio construction and risk management. The aim here, the purpose of portfolio construction, is to achieve a dual objective: one, to allow the portfolio to generate the highest possible alpha, while at the same time, on the other hand, mitigate the volatility of that alpha. Yeah, so alpha maximization and mitigation of volatility of alpha.
The way we seek to achieve it, in brief, is by allocating more capital to alpha-rich segments of the market in a risk-calibrated manner and less capital to alpha-deficient segments of the market. So if you're fishing in a pool where you know there are more fishes, you'll fish there, that part of the pond, to a greater extent. So as an example of allocating more capital to alpha-rich segments of the market, we all understand and I think can agree that SMID caps are more alpha-rich segments of the market because they're a more inefficient segment of the market. So we historically have allocated more capital to SMID caps, but you can't completely be out of large caps; it would be too risky a portfolio. So roughly half the portfolio, close to half the portfolio, is in large caps.
Even in large caps, we have generated alpha that is more than what most of the industry has been able to generate in their entire portfolio. So our team, as you can see, has delivered 14% return in large cap compared to 14.5 — but in mid-cap and small-cap, it is — sorry, portfolio return of 14 over 12, so 221 basis points alpha. As in mid-cap, it is 871 basis — these are annualized figures — 871 basis points annualized alpha in mid-cap, and in smaller caps, 22 percentage points of annualized alpha.
We also have the flexibility in the trust vehicle, or our trust vehicles, both India and EM, to be able to invest in pre-IPOs, before the stock gets listed, and that has fetched us very handsome returns. It requires a lot of skill and a lot of work, but if you're willing to do that, it can deliver very well, as you've seen.
The other — besides size, I won't go into details — but there are other segments of the market which are alpha-poor. So companies or segments of the market with poor governance or heavily regulated, they have lower alpha potential compared to better-governed segments of the market.
So this has been the performance of the trust, a very consistently strong performance. Now, one big caveat to highlight: you all probably compare performance of managers versus the benchmark. In case of India, it is somewhat of a far less relevant — or let me put it, distorted benchmark, because the benchmark doesn't pay tax, whereas in reality there are taxes, capital gains taxes in India. So you should compare against ETFs or compare against the peer group, because the ETF and benchmark difference itself can be 200 basis points over time, unlike what you'd expect, ETF versus benchmark to be 20, 30, 50 basis points.
Yeah, but with that, compared to the benchmark, which is unfair, we have delivered over 526 basis points since the IPO and over 600 basis points since the portfolio got invested. 18% compared to 12%. As a result, 100 would have grown to 286 in our NAV, whereas the benchmark is 215. The ETF would be less than 200. So delivered nearly twice the return compared to the ETF.
Performance has come vastly through stock selection. So overall 271 compared to 110 of the benchmark, 162 outperformance, of which 162 is from stock selection. As you can see, small cap is the largest contributor, but mid and large cap on their own would have beaten any of the peers out there. Similarly, across sectors, each and every sector the team has delivered positive stock selection alpha, and almost all of the alpha has come from stock selection when viewed from a sector attribution perspective.
Very well diversified, a diverse set of names in terms of contributors, coming from large caps like ICICI Bank and several of them are small caps like Laxmi Organics, from consumer staple groups to banks to technology companies to new-age companies. Very granular set of contributors. The 10th largest contributor is far higher than the top detractor. Everything — the composition of alpha is the way you would like to see, not just one or two names making up most of the alpha.
The portfolio composition generally doesn't change too much at a sectoral level. Energy and utilities, we struggle to find attractive investment opportunities. Otherwise, very well represented. Healthcare particularly, and consumer discretionary tends to be areas where we find a lot of attractive opportunity. These small caps, as I said, about half of the small and mid put together, about 60% of the portfolio. Large cap at this time under 40%.
The most compelling reason — now we are going to talk about macro, but before talking about macro for a few minutes, I want to remind investors again, this is a slide that I put together several years ago, or in some other form, this slide even prior to when it was published in the Wall Street Journal in 2018. The key reason, the most compelling reason to invest in India is the alpha opportunity. Yeah, I've hardly ever made the claim or made the assertion that invest in India because India is going to outperform other countries. The fact that it has done in the past is just a historical fact. Doesn't mean, again, I would state that India would necessarily outperform going forward.
But I still do believe, strongly believe, that India remains — and when I say I still do believe, I worked, I lived 11 years in the US, '95 to 2006, worked for eight out of those 11, and was investing client money in US markets. But personally, all my money was invested in the Indian market, not because I believed the Indian market would outperform the US market, but because I, despite working in the US market, believed I can generate more alpha in India. Those were my younger days; I used to believe I can generate 15 to 20% alpha. Markets, you know, taught me to rein in my expectations, but still the fact remains: India is a very alpha market, and that is the most compelling reason to invest.
Now this slide again is a 16, 17, 18-year-old slide, hasn't changed much. The long-term case for Indian equities — this slide might as well have been designed in 1992 and would not have changed over the last 32 years. So strong economic — once-in-an-era transformation of the economy starting from 1992. So we gained independence in 1947, so we are a democracy since '47, but we are really a modern-day economy since 1992. Yeah, so multi-generation opportunity, strong domestically driven growth, very attractive demographics.
You've all probably heard about it, how India's working-age population continues to rise in contrast to most other countries. But these are more about storytelling; these in and of themselves do not deliver strong returns. What delivers strong cash flow growth for companies and potentially returns for investors is a very profitable and diverse corporate universe with a 20-year ROE of 16 to 17%, one of the strongest in the world.
So that is because India has an entrepreneurially driven capital allocation, which then results into superior asset mix as well. But unlike many of the other emerging markets where capital allocation is top-down, particularly in authoritarian regimes, in India it's more entrepreneurially driven. I used to say that entrepreneurs in India are not interested in investing unless they can double their money in three to four years. Yeah, even today I would say they want to see money doubling in four to five years, meaning high-teens returns before investing, because there's just a large set of opportunities and scarce capital, so you can afford to be more picky about where you invest as an entrepreneur.
Most importantly, and this is a point that resonates more with the audience over the last couple of years with what's happened in Russia and China, even though this bullet point has been there for the last 17 years, which is that India has the institutional infrastructure of a mature democracy. Physical infrastructure, it is there for everyone to see and everyone has been critical of for decades. I see that more as an opportunity. Globally, when physical infrastructure has improved, as has been the case for the last more than three decades in India, it aids growth, accelerates growth, and to the extent growth is better for investment, that is helpful.
But changes or developments in institutional — the political infrastructure of the country is not always rewarding. Yeah, it can go through upheavals which can be very punishing to equity market investors. In India, so I jokingly say the best thing that the British left behind in India isn't the Indian game of cricket, but it is the, you know, the institutions that India has since preserved and even improved upon along the way, which ensures ultimately it's about property rights under a common law system, which obviously the British left behind.
You know, you can't underestimate the importance of this very last bullet point, because what you are buying when you're buying a trust investing in any country, what you're buying ultimately is the underlying companies. What are the underlying companies as investments? They're nothing but perpetual — right, or property right to the perpetual cash flows of the company. If those rights are weak, you would not pay — you might not buy at all, or would pay a very steeply discounted price.
You know, the reason why globally people are comfortable buying a piece of property in London or anywhere in Britain or such countries is because they're very confident of the property right they have when they buy a piece of property here, and the property right can be passed on over generations. Yeah, and that is why the property prices are in Britain and London what they are. And so that is very crucial.
In many authoritarian regimes, and there are several in EM, there is only a mirage of property rights. Yeah, let me take an example of Russia, which used to be part of the investible EM universe. It's just a mirage of property rights. Everything had a first call option was with Putin. Yeah, and there are many other countries still in EM — I won't name them all — but there are barely any property rights.
I do at this point often get prompted about Vietnam, and if there is a question I'd love to address that later, but in the interest of time we'll keep moving, as I have about 10 minutes. So I'll try to wrap up in three minutes and leave seven minutes for questions.
India has delivered very strong nominal GDP growth rate over the last 32 years. As I said, '92 is when things began as an economy. Because of the entrepreneurially driven capital allocation and the democratic institutions that I talked about, the earnings per share growth in India has also been 12.5%. These are rupee terms. So if you translate into dollars, shave off 4% or so, so 8 to 9% is very good in dollar terms, and that has translated into about 12% return from the market in rupee terms.
This relationship doesn't always hold true with all the countries, but does hold true with most of the countries. And I haven't seen the numbers, but I would guess it holds true of UK, US, and other developed markets and democracies in general. ROE is, as I said, one of the strongest globally.
Now people often associate high valuation with India because over the last few years Indian markets have done much, much better compared to other EMs or even developed markets. But that's because of strong earnings growth. So if you're comparing the Brazilian, Chinese, or EM on average, you know, those markets haven't done well because earnings growth hasn't been there. In fact, it's been degrowth, as India has been compounding at one of the fastest paces.
Valuation, again from a historical context, over the last 10 years India is right in line with the average, and after today it is below average possibly. Yeah, this is as of last month end. Compared to EM, the premium is higher because of a structural derating in China, because as you can see, India's multiple has not gone up. So the premium has gone up because, led by China, EM has gotten derated, as China is such a big component.
Democracies, for the reasons that I talked about when I talked about property rights, democracies forever have been trading at a huge premium to authoritarian regimes. Yeah, at the turn of the century they were nearly more than twice the multiple of authoritarian regimes. So it's not the first time that democratic countries are trading at a premium. In fact, in the past they have been much higher.
I'm going to skip all these. The macro environment has been very stable and benign in India. Inflation has been mostly a developed market problem. In India, last 20 years inflation has been 5%. 5% is the equivalent of 1 to 2% in Britain. If we had 1 to 2% in India, it would be very uncomfortable. Yeah, and feel like deflation, which is not comfortable. GDP growth rate has sustained over 6% in real terms. Fiscal deficit under control, current account deficit very benign.
A lot of reforms in the right direction over the last 10 years under the Modi government. Some very hard structural reforms, then growth-enabling reforms, and now further reforms to enhance ease of doing business. Has dramatically improved. From, you know, last time it was reported, India jumped from 146th rank to 63rd rank. Obviously it's not a comfortable place. I often jokingly say India would feel very unhappy if we were second in cricket, so why do we accept 63rd in ease of doing business, which has more direct bearing on standard of living of the country?
The investment in capital infrastructure has accelerated over the last 10 years, as you can see here. A lot of examples. One that I would highlight: social infrastructure. Rural homes with running tap water have jumped from [a few] million to 144 million over the last 10 years. So a very crucial form of infrastructure, as people otherwise waste so much of their time just getting water to home.
Credit cost in the system, the banking system is very healthy, 20-year or decade-low levels. Corporate leverage at their lowest levels. Real estate inventory at cycle-low levels. Private sector projects expanding. China plus one, India is the preferred alternative. This is a Japanese survey, but reflective of what's happening worldwide.
India as a percentage of corporates talking about India as a preferred destination has jumped. In '22, for the first time, became the first destination ahead of China, and in '23 jumped further while China declined. A 17 percentage point swing: plus 8.3, minus 8.7 in one year. I think that's an unprecedented swing.
And it exemplifies and is one of the biggest endorsements of India's manufacturing sector, led by which our electronics exports have been compounding at a rate of 26% over the last several years from the first supplier setting up base in India. And this was, in my view, instigated by Trump's campaign in 2015, when he started making, you know, very vicious comments against China, and corporate leaders worldwide and board members started wondering, what if he delivers what he's saying? We better diversify our supply chain.
And so from there till now, where Apple is producing mid-teens percent of their phones in India.
We have a fantastic board that, besides safeguarding the interests of investors, has also provided an enabling environment, a conducive environment for us as a manager to do what we do and deliver strong returns to investors while keeping an eye on the risk as well. So I will pause or stop there and see if we have any time.
