The drivers of India’s growth over the next 10 years will be different from the past decade.

India recently achieved a significant growth milestone by temporarily surpassing China to become the largest weighting in the MSCI Emerging Market Investable Market Index (MSCI EM IMI) in September. That feat reflects the success of Indian companies in translating economic growth into earnings growth and investors’ confidence in future growth.

The portfolio managers of the JPMorgan Indian Investment Trust plc (JII) see this growth as evidence that India is starting to deliver on its long-term potential. They also believe that as the Indian economy continues to evolve, the growth drivers are changing.

Capturing structural and cyclical opportunities

Some of India’s growth will come from major investments in the country. India is moving from a benign capital spending (cap ex) cycle to an accelerated one. One key area of fixed asset investment will be in infrastructure, especially power generation and distribution. In addition, a real estate cycle appears to be emerging for the first time since the global financial crisis.

These trends will impact companies across many sectors, not just those directly related, such as power generators or property companies. JII is more likely to invest in manufacturers of cement, steel, ceramic tiles or turbines, which tend to have higher returns on capital than property or power generation companies. Some of the companies that will lead this next wave of growth are in new businesses that didn’t exist in earlier growth phases, such as platforms for logisitics, financial services or travel.

Positioning for growing wealth

Indian consumers currently have a collective USD 650 billion in household savings, which is expected to reach USD 1.1 trillion in five years and USD 1.7 trillion in 2035. Currently, approximately 70% of household assets are invested in property or stored in gold. Despite India’s booming stock market, only about 5% of assets are invested in equities, compared to around 40%-45% in the US.

The portfolio has significant exposure to a diverse assortment of financial companies that have different roles to play as India’s economy grows. These holdings include a few banks, such as a large position in ICICI Bank, that will help finance growth and benefit from increasing consumer wealth. However, the trust has more exposure to other types of financials companies with attractive business models, such as stock exchanges, insurance companies and asset managers; these will also benefit as household wealth grows and shifts into other financial products and services.

Increasing discretionary income will also continue to drive growth across a wide range of consumer products and services. The portfolio is positioned to capture trading up across consumer staples products as well as increasing discretionary purchases in durable goods (Blue Star, an air conditioning and refrigeration company, is a new position) and autos (Bajaj Auto, a motorcycle and scooter manufacturer, is a top active position).

Healthcare is another area that is likely to benefit from growing wealth and the portfolio managers believe that generic drug producers with high quality manufacturing capabilities, such as Dr. Reddy, are well positioned for growth.

Considering valuations in context

The Indian stock market has been a top performer across global markets and valuations in some parts of the market are now looking rich. However, it’s important to consider valuations in context. India’s economy is growing faster than many others and has a highly entrepreneurial culture. Critically, many companies have high growth rates and high returns on capital, which the JII portfolio managers believe are the key drivers of stock returns and valuations.

The Indian market is big and broad enough to find plenty of opportunities, especially for a strategy like JII that can invest in all market capitalisations. Although some small cap companies currently have very high valuations, JII has a few positions in small companies that could have substantial upside if the businesses are able to execute on their plans for growth. Companies such as Delhivery, an integrated logistics service provider, BP Fintech, an online insurance and lending platform, and Make My Trip, a travel website, could eventually be much larger positions in the portfolio.

JII’s portfolio managers have found plenty of opportunities in mid cap companies, where valuations are somewhat more reasonable, and large caps. Roughly 80% of JII is invested in stocks that are internally classified as premium or quality, and in companies that have relatively low levels of leverage—yet the portfolio’s valuation is similar to the benchmark’s. That means JII shareholders are invested in a higher-quality portfolio for a similar price.

Looking ahead

The portfolio managers believe that corporate fundamentals ultimately drive market valuations and rotation. While lower-quality, deeply cyclical stocks drove much of the Indian market’s return over the past year, in the past three to six months, signs of some rotation into higher-quality businesses are emerging and the portfolio managers expect this trend to continue as companies deliver on earnings expectations. In the meantime, they continue to position the portfolio in high-quality businesses that are especially attractive on a risk-adjusted basis and are aligned with shareholder interests.