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David Kimberley
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Updated 14 Oct 2022
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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by Ashoka India Equity. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Writing about investment trusts tends to focus on strategy, portfolio holdings, and performance. That’s understandable, given most people want to know how the managers go about investing, what they actually hold, and the results those two things have produced for shareholders.

Focusing on these points can make you forget that there is typically a large group of people underpinning them. Without a team of analysts attending company meetings, sifting through financial reports, and looking at valuations, no strategies would be in put place and no stock buys would happen.

Having a large research team is unlikely to be a hinderance to a fund’s success, but it’s also not always necessary. Take the US stock market as an example. According to Furey Research Partners, the average US large cap stock has about 21 analysts covering it.

Even if you go down to micro-caps, US companies have an average of three analysts covering them. Considering that in other developed markets, like Japan or the UK, it’s not uncommon to have no analysts at all covering companies of this size, this is a relatively large number. Combined with lots of publicly available information and easy access to various data points, this makes covering US stocks comparatively easy.

This is not the case in many regions of the world, including India. Although it’s still put in the emerging market bucket, something investors tend to associate with a narrower investment universe, the Indian stock market is vast. Like the US, there are at least 3,000 publicly traded companies today in India.

Purely because it doesn’t attract the same level of interest among investors, there simply isn’t the same level of information available about lots of these companies as there would be with their peers in other markets. At the same time, the level of analyst coverage is much lower, with many companies having no analysts covering them at all.

For managers this presents both a challenge and an opportunity. The challenge is that you have to do a lot more legwork to figure out which companies are worth investing in. But the reduced level of competition means that there is a much better opportunity to find companies that are undervalued.

The proof is in the pudding on this latter point. A common metric used among professional investors to understand the additional returns delivered by an active manager, beyond the return delivered by movements in the underlying index, is alpha. Effectively it is numerical evidence of the skill of an active manager. A Wall Street Journal investigation, that looked at the average alpha delivered by active managers across different regions over the five and ten year periods to the end of 2018, found that managers focused on Indian equities delivered by far the highest level of alpha.

What that suggests is that, although it may be much easier to get information about companies in markets like the US, the result is that finding market inefficiencies to take advantage of is trickier. In contrast, managers who have the skills and resources to add real alpha can have more of an impact in India.

One investment trust that illustrates this dynamic is Ashoka India Equity (AIE). From the trust’s launch in July 2018 until the end of September of this year, the trust delivered annualised returns of 19.4% on a net asset value (NAV), total return basis. This was far ahead of the 13.1% delivered by the MSCI India IMI, AIE’s benchmark index, as well as being ahead of all the trusts in its peer group.

AIE has over twenty analysts on its team, a sizeable number for any trust, but particularly high for a single country fund. Perhaps more importantly, the team works on the ground, with the majority of analysts based in India. The team carry out thousands of meetings per year, with a big focus of the investment process being on corporate governance.

But another reason the managers believe having a large research team is necessary isn’t just because of the large number of companies that are publicly traded in India or the need to ensure corporate governance standards are high. It’s also due to the sectoral diversity that exists in the market.

Apart from financials, which constituted a little less than 25% at the end of September, no sector has a weighting of greater than 15% in the Indian stock market on a market cap basis. By comparison, almost all other major emerging markets are heavily skewed to one or two sectors. For example, the Korean and Taiwanese equity markets have weightings to technology of 40% and 65% respectively. It’s a somewhat similar story with Brazil, which is dominated by energy, commodities and financials.

Again, this provides both a challenge and an opportunity for India analysts, who arguably need a wider set of specialities than their peers as a result. AIE has taken steps to try and benefit from this state of affairs. For example, the trust has a team of four analysts who are focused solely on the healthcare sector, with the lead on that team having direct experience in the industry, as well as extensive experience as an analyst.

Complementing all of this is the fee structure that AIE has created for its analysts. AIE charges no management fees. Instead, a 30% performance fee is charged on any alpha delivered over three-year periods. That fee is paid in shares, half of which are locked up for a further three years.

For analysts working at the trust, fees are allocated based on how stock picks contribute to performance. The analysts that contribute more to generating alpha are rewarded more if any performance fees are paid.

This system does appear to have paid off so far, given that AIE has delivered returns far in excess of those produced by both its peers and benchmark. Past performance isn’t indicative of future returns, but as we head into a period of economic uncertainty, shareholders may find some comfort in knowing that AIE has such a large and experienced team at its disposal.

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