Neptune: Mid caps are India’s next biggest story

India-Emerging-Asia-Taj-Mahal-700.jpgMid-cap stocks are the big story in India as valuations and corporate earnings pick up, says Kunal Desai, Neptune’s head of Indian equities.

“In India, there is more domestic money coming in and running at a healthy rate and when you have that acceleration it is good for mid caps,” he says. “People keep seeing India as a structural story and the biggest story is mid caps.”

“Investors have focused on the wrong things in India and ignored the corporate story as earnings are going to pick up,” he says.

Domestic mutual fund flows have grown to almost 8 per cent since 2008, and this particularly picked up in the past two years, where inflows were at a rate of $1bn a month, Desai says.

The outlook for flows are promising too, he says, as household savings into equities are expected to grow from 3 to 5 per cent in 2018. He says this will equate to $75bn in the next three years versus $35bn over the past six years.

Looking to mid caps, they are trading at a 29 per cent discount compared to their large cap counterparts, says Desai. Nearly 33 per cent of the £88m Neptune Indian fund is currently invested in small and mid caps compared to 12 per cent for the benchmark.

The fund manager says he looks at companies that can guarantee continued investment in the business, and convert these investments into sales to generate cash.

As an example, he picks Asian Paints, one of the largest Indian paint company manufacturers, which also “fits the bill” in terms of corporate governance success.

He says: “Asian Paints has a tremendous mode around brand and distribution. They spend 5 per cent of their sales on advertising and commercial, which is more than three times their peers in the sector.”

Within the Neptune Indian fund, Desai is overweight financials, particularly private banks.

He is currently boosting allocations to industrials, consumer discretionary and financials, which make 10, 15 and 23 per cent of the fund respectively.

However, some headwinds face the country, says Desai, including any increase in the oil price, which could generate risks. However, that is not Neptune’s base case.

“India of the next five years will be different. It has the lowest correlation with emerging markets and anything that happens in China or Greece doesn’t have a big impact,” he says.

India’s GDP is set to grow at 7.6 per cent in 2016 and reach 8.1 per cent in 2017, according to Neptune estimates.

Desai says: “A more proactive central bank policy has also meant India’s external vulnerability has fallen fast. India has a sustainable current account deficit compared to other emerging market countries such as Indonesia, Turkey, Brazil and South Africa and currently stands at -0.7 per cent.”

Since Desai took over the fund’s management in 2012, the fund returned 32.6 per cent against the 22.7 per cent of the MSCI India index, according to Lipper. Year to date, the fund returned 2.71 per cent against the 0.9 per cent of the index.