An update on global capital

A significant shift in international investment dynamics is underway

I had the opportunity recently to meet with asset allocators and money managers across the World. They run the most sophisticated pools of capital that operate on a very long-term basis, optimising risk-adjusted returns. We had a series of discussions on India, emerging markets (EMs), and their view of the world.

Here are some key takeaways:

1. In previous meetings, there were many allocators who had not given up on China. Many felt that China was experiencing a cyclical low in terms of both geopolitical and economic performance. A year ago, some investors were still looking for a long-term cheap entry point to put money back to work in the country. Today, the mood is very different. Everyone has limits on their China exposure, set by the board or their trustees. This is not a decision made by the investment teams but falls more in the realm of getting ahead of potential government regulations and avoiding headline risk.  Regardless of how attractive China’s valuations may become, a lot of investors will not put more capital to work in Chinese assets. If China were to rip higher, everyone would get a pass for missing it, but if the markets tank further, the consequences of remaining invested are perceived as too severe. The only exceptions were some single-family offices that are not driven by the board-trustees dynamic.  They remain contrarian. While most institutions will eventually cut their China exposure by almost half, the weak performance of Chinese capital markets is already driving allocations downward. Many have sold most of their listed equity exposure to China but are stuck with illiquid private assets. It will take years to get this money back as most China private funds know they cannot raise any additional capital from the US and, hence, are in no hurry to return what they currently manage. While the rebalancing away from Chinese financial assets is a clear mandate, it will take 3-5 years to fully execute. China plus one in capital flows is not going to happen immediately.

2. Many of the institutions I met also have short-term liquidity pressures. They have too much exposure to private investments and the expected distributions have lagged. This is temporary and will be corrected over the next 12-18 months. Interestingly, Bytedance, the Chinese owner of TikTok, was the largest private exposure for almost every institution. The liquidity pressures are also slowing the movement of capital from China to India, as any money pulled from China is currently being used to address short-term liquidity needs.

3. We saw a high level of interest in India among allocators who historically have not bothered with the country. A lot of people have clearly been doing work to gain contextual awareness of the investment landscape in India. The fact that over the coming five years no other large country had visibility of 6-7 per cent economic growth with stable macro indicators, and the potential to deliver 12-15 per cent earnings growth was mentioned in every conversation. The ability of India to deliver high-quality compounders was also mentioned on multiple occasions. Active stock picking was still seen as the way to go. There was a sense of the “There Is No Alternative” (TINA) factor at play, as many other large emerging market countries faced more significant challenges.

The rise of the domestic investor base was being tracked closely, which was seen as a structural positive. Many commented on the Indian market’s resilience, as evidenced by the $40 billion in foreign portfolio investment selling between October 2021 and mid-2022, which was entirely absorbed by domestic capital. The strength of domestic sentiment was appreciated and seen as a leading indicator of confidence in the long-term prospects of the country.

4. The primary concern regarding India is its valuations. India is now, along with the US, the most expensive market in the world. Most allocators are naturally hesitant to commit capital with such high expectations already priced in. The most common questions remain on what can go wrong and what are we missing? What are the flaws in the India story? Some mentioned that we have been here before only for India to disappoint in the past. Why is this time different? My sense is that on any correction, a wall of money is waiting to come in, as few doubt the long-term potential of India. Every allocator we met was clear that five years from now they will have a lot more capital in India than they have today. While new investors are hesitant to commit capital today, most of the existing India investors are happy to live with the current valuations and keep their allocations largely unchanged. I heard the comment that India has always been expensive many times from this set of investors. There seemed to be no desire to take profits off the table in any significant manner.

5. There was little concern about the upcoming elections. Most global investors seem to assume that the current political dispensation will continue for another five years. I was surprised by the lack of any debate.

6. It has been the absolute right thing to be overweight US equities over the last 15 years. The home bias has worked. Some wondered about EM as a relevant asset class. Almost no one has a pan-EM manager anymore. They have specific country/regional funds. Even looking forward, the US has all the innovation, is energy surplus, and has the best demographics and companies in the West. The question many investment committees are asking is, why go outside?

7. Most allocators were cautious about global risk assets. The US has a horrendous fiscal position, with no obvious way out. Its fiscal deficit today is the same as it was during the depths of the global financial crisis, despite sub-4 per cent unemployment today. Based on some realistic assumptions, US government interest payments will cross 10 per cent of gross domestic product and 60 per cent of tax revenues within a decade. Absolute interest costs will increase by over $1 trillion as the stock of government debt gets repriced.  Interest rates will probably rise further and remain higher for longer.

A recession in the US in 2024 is still the base case for most of these investors. We are in a new world with most currently active investors having only experienced falling rates. Expect more defaults as refinance risk is now real, and few realise that 30-year bonds in the US have halved in value. While equities were very expensive relative to their own history, they were very cheap compared to bonds, this has now entirely reversed and equities in the US are just flat-out expensive. Absent the magnificent seven technology stocks, the S&P 500 is actually down for the year. This valuation combined with a view by many that the US dollar has also peaked is causing some to look beyond the home bias of the last 15 years. Europe also has structural challenges, on energy, demographics, and economic rigidities. It is very tough to be bullish here on a longer-term view.

My sense is that money will come to India but it will take some time to materialise. Valuations are a real stumbling block and a market correction would give new investors much more comfort. The long-term case for India continues to gain traction, and the opportunity is ours to lose.

The writer is with Amansa Capital