Stalking India's Tigers

04/15/2010 11:44 am EST


Sharat Shroff

Portfolio Manager,

Sharat Shroff, lead manager of the Matthews India Fund and the Matthews Pacific Tiger Fund, favors the smaller stocks poised to drive the next spurt of Asian growth. The Matthews India Fund (MINDX) is in the top 1% of its Morningstar category [Pacific Asia ex-Japan stock funds—editor], up 14.5% year-to-date. How are you doing it?

Shroff: We have an above-average allocation to small- and mid-cap stocks, and these suffered disproportionately during the bear market. However, the fundamentals of these stocks held up in some cases better than their larger-sized peers. That has helped drive the outperformance in small and mid-sized stocks over the past year. [So far this year,] select holdings in financials, media, and health care have helped generate relative gains for the portfolio.

Q: The stereotype of India is that at the local level, red tape is tremendous and the business environment difficult. Is that still true?

A: There have been many positive changes over the last ten years, and the government is intent on deregulating many sectors of the economy. Many of the companies we invest in were started by entrepreneurs, and the entrepreneurial class in India is still growing. As the economy liberalizes, they are delivering very strong growth and earnings.

Q: How much of this is already priced into the Indian market, which has more than doubled from last year’s bottom?

A: Indian stocks are not cheap; they’re at the upper end of the of their valuation range. But we don’t [time the market], and from a long-term perspective there are still tremendous opportunities in this market.

Q: Can India’s growth continue despite the recent burst of inflation? And are the coming rate hikes a big risk for investors?

A: That is something we’re watching extremely closely. There has been a recent surge in inflation, especially food inflation, though that now seems to be abating. [Inflation was running at an annualized 10% according to the latest statistics—Editor.]

The good news is that India has a central bank that has shown itself willing to do what’s necessary to keep inflation in check. But there is no doubt that higher interest rates will present a challenge to corporate India, and the progression in earnings is not going to be as easy as last year. Investors need to have a longer time horizon with their Indian investments because the market has been known to be volatile.

Q: Some people argue that India deserves a premium to China, because it is much more decentralized and market-driven. Do you buy that?

A: We would prefer to evaluate companies instead of countries or economic systems. There are good companies in China as there are in India. It’s true that Indian companies overall are less dependent on exports than Chinese ones [are.] The greater focus on domestic markets has shielded corporate India from significant volatility in earnings. [But] the Indian equity market is more influenced by global investor flows, which tend to link stock price movements to global factors.

Q: Your fund has invested very heavily on financials and industrials. Is that a bet on further development of financial and industrial infrastructure in India?

A: Yes, it is. We believe Indians will be much bigger users of financial services in the future, and our overweight on the financial sector reflects that. We’re also overweight consumer and industrial stocks, because India’s domestic demand, both consumption and investment, should continue to grow faster than the global economy.

Q: Crompton Greaves (Bombay: CROMPTON) is one of the largest holdings in your portfolio, yet it’s not well known to most investors. What do they do?

A: Crompton Greaves makes power-generation, transmission, and distribution equipment. They’re a well-run [mid-sized] company in a fast growing market, yet they’re much cheaper than Western competitors, like Siemens (NYSE: SI) and ABB (NYSE: ABB). The gap has shrunk over the last year, but they’re still some 20% cheaper. And yet domestic demand for their products is high and their margins are expanding.
Q: Another company among your top holdings, Jain Irrigation Systems (Bombay: JAINIRRIG), also seems to be a bet on the infrastructure buildout theme.

A: Yes, they don’t make anything unique, but they’re known to farmers particularly in western India and they have a network of rural dealers that would be very hard to duplicate. They are a beneficiary of greater investment in irrigation, which is a focus area for the government.

Q: For your pan-Asian Matthews Pacific Tiger Fund (MAPTX), in what countries and industries are you now seeing the best bargains?

A: We’re overweight Indonesia and India relative to benchmarks, and underweight Taiwan. We’re also favoring banks and industrials.

Obviously the steep discount we saw at the lows last year is gone. But there are still opportunities for a diversified fund like Pacific Tiger, particularly in some of the smaller markets [that] are not attracting as much attention [as] China and India. Nonetheless, with the run-up, investors need to approach these markets with patience, and longer time horizons.

Q: Could you tell us a bit about one of your top holdings, Hang Lung (Hong Kong: 0101)?

A: They’re a Hong Kong commercial property developer that’s now building their portfolio in the mainland as well. Their Shanghai mall, Plaza 66, has been a success, [enjoying] 90%-plus occupancy rates even during the recent slowdown in the Chinese economy.

Q: So, you’re not worried about all of the bubble talk about Chinese property?

A: There are pockets of the Chinese residential real estate market where prices may have run ahead of income growth. But that is not true for the entire economy. Income growth in China is still fairly strong, growing at a mid-teens rate. As far as stocks are concerned, we watch valuations constantly, and prefer to hold companies where management teams tend to have a healthy dose of conservatism in their business plans.

Q: Thank you.

Igor Greenwald

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