Risk of irrelevance?

The scale of the selling and the speed and magnitude of the underperformance in Indian equities are unsustainable

I have been investing in Indian equities for over 30 years. Rarely have I seen foreign sentiment this bad. India no longer features in global conversations. What I am saying is not new. Since the Indian market’s peak in September 2024, we have seen $65 billion in net outflows by foreign portfolio investors (FPIs). Over the last decade, India has received zero net-foreign flows.

 

The stock of Indian equities owned by foreigners has fallen from $930 billion to about $675 billion, and foreign ownership as a percentage of the market is now at a 15-year low. India is now a consensus underweight for all global investors and our weighting itself has shrunk from 21 per cent in September 2024 to about 10 per cent today (MSCI Emerging Market index).

 

One company, TSMC, has a benchmark weight 50 per cent higher than that of all of India! The three EM heavyweights — TSMC, Samsung Electronics, and SK Hynix — together account for 30 per cent of the index, but have almost three times India’s weighting.

 

We have also seen unprecedented underperformance. Since the peak in September 2024, Indian equities are down about 25 per cent in dollar terms, even as the EM indices are up about 50 per cent. We have, therefore, underperformed by 7,500 basis points (75 percentage points) in the last two years alone. I have never in my career seen this quantum of underperformance in this short a period. It has destroyed careers and blown up funds. There are numerous funds that have destroyed 10-year track records in the last 24 months by simply being overweight India.

 

Normally, I would look at these statistics and numbers as contrarian indicators. This is exactly why I would argue — and still do — that we will soon see a turnaround in India’s relative and absolute performance. The scale of the selling and the speed and magnitude of the underperformance are unsustainable. How can three companies in Asia have three times the index weight of a country with India’s size and potential?

 

How can these three companies have a combined index weight of 30 per cent, almost identical to the combined weight of India and China, at 30.5 per cent? Something is clearly wrong. It seems ludicrous that three Asian technology companies can have an index weight almost equivalent to 40 per cent of the world’s population. A classic contrarian indicator, if there ever was one.

 

However, what troubles me is that for the first time I am now being asked about the need for an India-dedicated allocation. Many allocators no longer think India is important enough to warrant dedicated exposure. Why bother with sticking their neck out and betting on India specifically, especially given the extent of underperformance. This conversation has come up now after years. Twenty years ago, every allocator had dedicated money in China and Brazil, and India was a debate. Over time, it became conventional wisdom that to invest in EM, you needed dedicated pools of capital for India, greater China and Brazil. If allocators are now unwilling to make an India-specific bet, it is a big negative and will constrain the quantum of foreign equity as well as the diversity of capital into the country. Non-dedicated exposure by definition is more cyclical.

 

So why this change in thinking? First of all, it is the decline in India’s EM weighting. At only 10 per cent, we are half what we used to be and three countries — Taiwan, Korea and China — are 70 per cent of the EM index. Do you really need to bother with India? Even getting India wrong will not really move the needle. Over the last 10 years, India has anyway underperformed the EM indices by about 180 basis points annually. Even on a 20-year basis, India has just marginally outperformed. The narrative that you need to be in India because of the quality of companies, sustainability of growth and entrepreneurial energy is getting lost. There is fundamentally less belief that we have decades of strong growth ahead of us.

 

Second, many investors have come to the conclusion that India may not deliver enough absolute returns. Their calculations are as follows. The Nifty index in rupees has delivered about 10.5 per cent per annum over the last 20 years. Assuming a capital gains tax impact of about 15 per cent (the average of the short-term rate of 20 per cent and the long-term rate of 12.5 per cent), this brings the return down to about 8.9 per cent. Then, assuming a near 4 per cent rupee depreciation (the average over the last 20 years), this brings the return down to about 6 per cent in dollar terms.

 

Why bother with 6 per cent when the 100-year annualised returns in US equities are about 10 per cent? I would argue that 25-year Nifty returns are near 13.5 per cent not 10 per cent. Nifty returns understate market returns and assuming continued 4 per cent currency depreciation makes no sense given the narrowing inflation differentials. Also, given the valuations, can you assume continued 10 per cent compounding in the United States? However, it does not matter what I think, this is what investors are saying.

 

All allocators are upset about the capital gains tax. They do not pay these taxes in any other major jurisdiction. It drops projected long-term annualised returns by about 2 per cent and that is a huge difference when comparing countries over long holding periods. There is also the perception that India remains a complex place to do business. Indian service providers do a good job of scaring the risk and compliance teams of global investors. While this may be unfair, the perception sticks.

 

India is also seen as the biggest global loser from artificial intelligence (AI), as our key advantages of demographics and a skilled white-collar workforce lose relevance in an AI-first world. Innovation and research & development, which are driving value creation globally, are seen as areas of weakness in India. One can refute this argument, but many allocators believe it.

 

India is also caught in a no-man’s land, not cheap enough for value investors to pile in but not growing fast enough to attract growth investors either.

 

If India were to lose its attraction as an independent asset class that is a cause of worry. We will attract less structural capital and be of less relevance to global allocators. Not a good place to be for a country fundamentally short of capital. Equity markets are a competitive advantage for India, we weaken this if we lose access to dedicated pools of long-term capital.

 

I remain convinced that all this data is more a contrarian indicator and not a reason to turn more negative on India. Much of this is cyclical and the tide will turn. However, we must guard against slipping further down the investor consideration set in the meantime.

 

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The writer is with Amansa Capital