JPMorgan Indian bet on cyclicals and lost

JPMorgan Indian bet on cyclicals and lost – JPMorgan Indian says that, for the year to 30th September 2020, it underperformed its benchmark by a considerable margin – returning -16.2% in JNAV terms against -4.2% for the MSCI Indian Index. A widening discount left shareholders with a return of -23.2%.

The board says that “over the past few months the board has had regular meetings with the investment managers to understand the reasons for the company’s underperformance and the steps that are being taken to address it. Whilst the fundamental principles of the investment process have not changed, the portfolio has been repositioned and the number of stocks within the portfolio has increased in order to reduce stock specific risk. We expect that these changes, which are ongoing, will bring about a significant improvement in performanceThe board judges performance over the longer term and the underperformance in recent years means that the company has now underperformed the benchmark index over three, five and ten years. We continue to support the investment managers in their process and their stock picking rationale but, as you would expect, the board is monitoring performance closely. In addition, the appointment of Ayaz Ebrahim as joint investment manager provides greater oversight, in particular of portfolio construction and risk.”

Extract from the managers’ report

The tilt towards cyclically oriented sectors hurt performance. The long-standing overweight position in our favoured sector of private banks was the largest detractor; our emphasis on quality names did not help as the sector was indiscriminately sold down due to the turmoil in the macro environment. Specifically, the overweight exposure to IndusInd Bank was the largest detractor in the sector as the stock fell sharply due to concerns about its loan book, in the backdrop of the implosion of Yes Bank. Other core holdings in private banks, such as HDFC Bank and Kotak Mahindra Bank also underperformed even though their businesses did well through the period and continued to gain market share from state-owned banks. We believe this positive trend is likely to continue and remain confident about their prospects in the long term. Over the period under review, our underweight positions in corporate lenders such as ICICI Bank and State Bank of India, and other financials such as Bajaj Finance and Bandhan Bank, helped to mitigate the negative impact of our overweight exposure to the financial sector.

The exposure to cyclically oriented sectors such as industrials (Larsen & Toubro), building materials (Ultratech Cement and ACC) and consumer discretionary (Tata Motors and EIH) were among the other key detractors as the cyclical outlook deteriorated, particularly after the outbreak of the virus. The underweight in the healthcare sector also negatively impacted performance as the sector rallied across the board following the outbreak of the pandemic.

At a stock level, our large underweight position in Reliance Industries was the biggest detractor from relative performance during the period under review, accounting for over 25% of the total underperformance for the year. Despite the extreme environment, Reliance Industries rose over 50% in response to the positive announcement of a series of divestments in its telecom and retail businesses. This boosted sentiment and, more importantly, helped the company reduce debt. During the pandemic-led sell off in February/March, the stock fell more than 40% from its previous peak in December 2019. At that point valuations became sufficiently attractive, and we initiated a position, almost halving the underweight exposure.

Stock selection in the consumer staples sector was another critical detractor, as the key overweight positions in ITC and United Spirits underperformed the market.

By way of contrast, the large holdings in major IT services companies (Infosys Technologies and Tata Consultancy Services) contributed positively to relative performance. We had added Infosys at the beginning of the review period, when the share price fell sharply in October 2019 following certain whistle blower allegations against the CEO and CFO. At that point, we felt that a strong board led by the highly respected Chairman, Mr. Nandan Nilekani, would handle this issue in a responsible and effective manner. Subsequently, we increased the exposure when an independent investigation found no merit in those allegations. The timing turned out to be fortuitous since the sector performed exceedingly well due to its resilience in coping with the pandemic, as the workforce switched seamlessly to working from home, with negligible disruption.

The overweight position in a number of mid and small cap stocks in the healthcare sector (Apollo Hospitals and Dr. Lal Pathlabs) and certain others, such as Multi Commodity Exchange (‘MCX’) and Jubilant Foodworks, were among the other key positive contributors. As noted above, the healthcare sector did well across the board, while MCX benefitted from the spike in volatility in commodities such as oil and gold. Jubilant Foodworks, which is the master franchisee of Domino’s Pizza in India, benefited as consumers switched to delivery during the pandemic.”

[Over the past six months, JPMorgan Indian remains bottom of the pile in NAV return terms for trusts focused on India (India Capital Growth Fund is the best-performing of these funds over that period – we recently published a note on that trust which gives some background on what is happening in the country). It looks to us as though JII’s managers’ mistake was to bet on a resurgence of growth in India. It may be that 2021 is a better year but resurgent growth could continue to favour smaller and medium-sized stocks.]

JII : JPMorgan Indian bet on cyclicals and lost

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