Of course, China’s problems are large. Any emerging market (yes, China is still EM) with a debt load of 280% of GDP is likely to get encounter a fiasco at some point. Add to that the breakneck speed of debt accumulation, quadruple since 2007, and we are almost certain to see some fireworks. Exactly how the country will get out of this bind is anyone’s guess. Debt to equity swaps, financial repression, outright repudiation, imprisonment of short-sellers, hope, and prayers, are all viable options in a country like China.
A serious recession in China will no doubt be ugly for India. China is India’s largest trading partner and accounts for almost 10% of its total global trade. More importantly, foreign investors are yet to wean themselves off the basket EM mentality. When stuff hits the fan, everything in the EM basket is a basket case, regardless of fundamentals.
But let’s shift our attention back home for a bit. India, post the global financial crisis, has experienced four mini-crises:
- 2011 – MSCI India was down 37.2% for the year
- 2013 – MSCI India was down 20.2% by end of Aug
- 2015 – MSCI India was down 16.7% between Feb and Nov
- 2016 – MSCI India was down 13.8% by end of Feb
Going back through the annals of financial media, we found the following India specific reasons for the sell-offs:
- High current account deficit
- High fiscal deficit
- High inflation
- High interest rates
- Low foreign exchange reserves
- Policy paralysis
Finally, here is how we currently stand on the aforementioned issues:
- Current account deficit – 0.7% from 5% in 2012
- Central fiscal deficit – 3.9% from 5.8% in 2012
- CPI inflation – 4.83% from 11% in 2013
- Interest rate – 6.5% from 8.5% in 2011
- FX reserves - $350B from $270B in 2013
- Policy paralysis – the most action oriented government and central banker in decades
So, fundamentally, India is progressing in almost the opposite direction as China. Operating under this big China overhang, but a tangible improvement in Indian economy, we, as your portfolio managers, have the following choices:
- Sell everything, wait for China problems to go away, and then buy when everything is OK.
- Pay up to buy some exotic China insurance and lock-in a loss equaling the hedging cost.
- Acknowledge the risk, keep adequate cash balance, and do what has worked so far. Use the volatility to buy during fire-sales and sell when the price exceeds intrinsic value.
To us, option c, by leaps and bounds, is the most optimal strategy. We firmly believe in India’s future as an investment destination. We also believe that following a contrarian, value strategy, like ours will lead to large outperformance over the long run. So we stick to it.
We made the following major changes to our portfolio in the last quarter:
Sold J&K Bank
We had bought this stock after devastating floods hit the state of Jammu and Kashmir, where the bank has 60% market share of both deposits and advances. Our bet was that central government aid will come, things will get fixed, business will be back to normal, and valuation will normalize. Not only has any of that not happened in the past year, but the bank has also made some serious blunders in terms of its lending practices. Our faith in the current management has been greatly diminished. More importantly, we believe that we have other, better opportunities for our capital under the current market conditions. We booked close to 40% loss on this position, a first for us. It hurt badly.
Bought Hindustan Oil Exploration Company
HOEC is an oil and (primarily) gas explorer with mostly non-performing assets. The promoter of this company is ENI S.p.A., the $120B Italian oil and gas major. ENI tried several times to offload its stake in this underperforming asset, finally selling a portion to a private investor a few weeks ago. ENI had also given a near-zero interest loan to HOEC, which it finally waived as the company was in no state to pay back. With no hope for a complete exit, ENI bought in new management and focused their energy on reviving two key gas fields, both of which are viable even at current depressed prices. This management team comes from Cairn India, country’s largest private oil producer. The turn-around is on track and if successful will result in reviving an asset base that’s at least three times it’s currently traded value. Finally, the company owns several currently non-producing assets that become viable at $50/bbl oil. This position is not without risk, but the commensurate reward, along with cheap optionality, make it a good fit for our portfolio.
In closing, though the portfolio has moved a lot, very little has changed in terms of its composition or our investing strategy. If you have questions regarding this letter or your portfolio, please do not hesitate to ask. As usual, you will receive your statements from NAV Consulting Inc.