David Kimberley
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Updated 16 Jun 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.

As much as fund managers talk about their aversion to investing based on short-term trends, markets tend to suggest that many investors end up doing just that. A wave of interest in ”green energy” stocks, for example, pushed up the market caps of various companies in the US and UK during the pandemic, even though some of them barely made any sales, let alone a profit.

Clearly, tapping into certain industries that are likely to see substantial growth or taking some heed of what is going on in the wider world isn’t an inherently bad thing to do. The trouble is that it often tells you little about whether a company is fundamentally good or not. A bad business in a growing industry is still a bad business.

The same principle applies to making those macroeconomic calls. Not only is it extremely difficult to get these right, it’s even harder to say that a specific company is going to benefit from them. And as with growth industries, even if a firm is in a sector that may benefit from certain economic changes, that won’t be of much help if it’s not in a position to benefit as much as competitors.

Hard as it may be given how tumultuous the world we find ourselves in is at the moment, it’s worth keeping this in mind when assessing the different investment trusts on the market today. Some may be performing well but it’s far from clear whether relative outperformance will be long-lasting. Others may have seen a dip in performance, even if the long-term doesn’t look to have changed much.

Ashoka India Equity (AIE) sits in the latter camp. From its launch in 2018 through to the end of 2021, the trust outperformed both its benchmark and peer group in every quarter bar one. Unsurprisingly, it outperformed in every calendar year period too.

This remarkable track record has taken a slight dint so far this year, as the trust delivered below benchmark returns in Q1, although the trust was still ahead of some of its peers. Paradoxical though it may sound, if you dig into why the trust underperformed, you actually get a sense of why it has managed to outperform in the past and may continue to deliver alpha in the future.

Energy and utilities businesses in AIE’s benchmark index, the MSCI India IMI, were a huge driver of the gains the index has seen so far this year. As the trust had no exposure to either sector this was likely the main reason it underperformed.

However, the trust has tended to be underweight to those businesses for good reasons. One is that the management team view energy companies as being heavily dependent on macroeconomic outcomes. As these cannot be predicted, it is also impossible to know when to buy and sell them.

Generally speaking, sectors like financials, healthcare, technology and industrials, with a large number of companies with heterogeneous business models may provide a greater number of compelling opportunities that are aligned with the team’s philosophy. The team also seeks to avoid companies with poor governance, structurally low returns on capital and those facing existential risk due to technological or other structural threats.

For investors, the question you have to answer is whether it’s preferable to invest in businesses that are performing well on the back of unpredictable market forces and may have poor governance systems in place, or to buy quality businesses that are more likely to deliver stable long-term returns.

Unless you have figured out a system to accurately predict macroeconomic trends, it’s hard to see how the former would ever be preferable. And for investors that do want exposure to quality companies then AIE may be an appealing option.

The trust’s managers sift through a huge universe of close to 800 stocks. Only a fraction of those are deemed investment-worthy and, of that group, only those that offer good value will be included in the portfolio, although others may be added if their shares drop to an attractive valuation.

A proprietary cashflow analysis system, focusing on businesses with good growth potential, and strong emphasis on corporate governance, all mean the AIE portfolio is optimised to contain the highest quality companies in the Indian investment universe.

That’s always likely to be a positive and may be increasingly so as we move forward. High inflation and the mix of instability we’re seeing in the world will require more robust businesses. Quality companies should, at least in theory, be more resilient to these problems, with stronger balance sheets and a greater ability to pass costs on to customers.

Long-term investors should see AIE’s performance in 2022 so far in this light. All companies are likely to see dips in performance at some point. But for shareholders it’s the long-term returns that matter, and AIE’s focus on quality seems well placed to deliver on that front.

The trust is now trading at a discount of close to 5%, a rarity since its IPO in 2018. Past discounts have not tended to be long-lasting and, although there is no guarantee that history will repeat itself, this may prove to be an attractive entry point for investors, with the potential for an additional uplift to capital if the discount does end up tightening.

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