India was one of the top performing Asian markets in 2003, along with Thailand and China (click here to view article on Best & Worst Funds For 2003). The run up in the stock market has been fuelled by relatively upbeat news on the economy. According to the Indian Central Bank, the economy grew 4.3% in 2003, and is expected to grow by 6-7% in 2004. Factors driving growth include expansion in the technology and pharmaceutical sectors. Indian tech companies, such as Infosys, have been huge beneficiaries of the outsourcing trend as robust demand from overseas clients boost revenues. Whilst Indian pharmaceutical companies such as Ranbaxy continue to maximize their low cost advantage in making generic drugs for export. It is estimated that India's annual drug exports, led by generic drug sales to the US and Europe is worth around US$2.5 billion.

But the Indian equity market is more than just technology and pharmaceuticals stocks, says Adrian Lim, fund manager for the recently launched Aberdeen India Opportunities Fund. He believes that privatisation of state-owned assets, growth in domestic consumption and low interest rates, are also compelling reasons to invest in Indian equities. While India has a chequered track record on economic reform, and its macro economic picture may not appear as attractive as say, China, there are fundamental differences between the two countries. One significant advantage for India is its diversity of well-managed domestic plays and globally competitive companies, that have been largely undiscovered by international investors. When it comes to profitability, Return On Equity (ROE) for Indian companies, is the highest in Asia, says Lim.

The Aberdeen India Opportunities Fund (click here to view factsheet) is approved for the CPF Ordinary Account. It feeds into the underlying AIF India Opportunities Fund, which invests in equities in the Indian sub-continent. In the 2-year and 1-year period ending 31 January 2004, the fund had an annualised return of 40.3% and 91.5% against a benchmark performance of 30.9% and 76.9%. Since inception in December 1996, the fund has returned 21.4% against the benchmark's 13.6% (see table below). In an interview with Fundsupermart, Lim talks about the rally in Indian equities last year, and whether the run-up can be sustained in 2004.

RETURNS OF THE UNDERLYING FUND AS AT 31 JANUARY 2004

RETURNS* OF THE UNDERLYING FUND VERSUS ITS PEERS AS AT 31 DEC 2003

Bharathi Rajan: Recently, there's been a correction in the Indian market. Is it a technical correction or is the market falling in line with fundamentals?

Adrian Lim: I think there's a mixture of reasons. The market did run-up quite well in 2003, and now it has caught its breadth a bit. During the last two quarters in 2003, you saw some of the stock prices rise and the valuations were no longer cheap. With the earnings results that were released for the third quarter of 2003 in India, you have seen that the earnings base is continuing to grow, but the PE multiples have correspondingly dropped. This correction is good because it allows for earnings to catch up with market expectations.

BR: What is the broad valuation (PE ratio) for the Indian market? Is it on the high side?

AL: For our fund it's about 16 times PE for 2004 and 13 times for 2005. This would be cheaper than the market. The SENSEX index is historically at the high end of the range. But the last time it hit the high end of the range was quite a few years back. Circumstances were different at the time. Since then, there has been more market reform, lower limitations on foreign share ownership, and falling tariff rates. So the market and the operating environment has changed quite a bit since the last time that the SENSEX hit its peak. So, we don't see why the market should not go beyond what is has historically achieved.

BR: Is earnings growth expected to stay strong in 2004?

A: Earnings growth is likely to stay strong. I would expect continued growth across all sectors. Some sectors will do better than others.

BR: Which are those sectors that will do better?

AL: You see a lot of earnings growth in the IT services sector, although the stocks are expensive relative to the rest of the Indian market. You will see a lot of earnings growth in the financial services sector, where historically you see low home ownership and credit utilisation levels. You will see more people, getting into mortgage financing and borrowing money to own homes or to buy motorbikes and cars. That is driven partially by falling interest rates, which allows the common man to gain access to credit. You can already see that the financial services sector is doing quite well.

We are upbeat on the industrials sectors, which will benefit from infrastructure investments. We also like pharmaceutical sector where very competent, cost effective business will continue to gain ground in first world markets. You see a lot of earnings growth in the IT services sector but the stocks are expensive relative to the rest of the Indian market.

BR: What is the size of the small caps that you own in the fund?

AL: For small caps it is approximately less than US$500 million, and they make up 11% of our portfolio. The benchmark MSCI India index has about 2% in small caps. For middle caps it is between US$500 million to US$2.5 billion. We have about 41% of our portfolio in there, whereas for the benchmark it is 22%. So on a relative basis, there is quite a big chunk of the portfolio that is in middle cap and small cap companies. We think that's where the growth will be coming from in 2004.

BR: Can you talk about some of the interesting stock ideas that you have in the fund?

AL: Hero Honda is the largest motorbike manufacturer in the world that is very well managed. It's a 20-year old joint venture between Honda of Japan and the local Munjal family. It trades at a PE discount to its local peers and delivers a strong dividend yield. Satyam Computer Systems is successfully penetrating the very competitive US market, realising very healthy growth and is one of the strongest software engineering companies in India. It is priced at a discount to its peers. Also, the industrials and the financial services sectors are doing well. At the moment we are neutral on oil and gas companies. However we do see good growth prospects along with some decent management teams, strong balance sheets and reasonable valuations.

BR: Will we see more volatility in the Indian equity market in 2004? If so, how will this affect the fund?

AL: You mean more volatility than the historical average? Probably not. The market was slumpy in the first two quarters of 2003. And in the third and fourth quarter even when there was a bomb blast, the market just kept on going. So 2003 is not as volatile as it could have been. The Pakistan and India issue is one risk factor. The falling US dollar is not such a pressing issue, but it affects the perception of the market. I don't think that it will be very different from what you saw in 2003, and looking back, I think 2003 was relatively good in terms of volatility. At the end of the day, we operate well in volatile markets. Volatile markets allow the quality companies to differentiate themselves from the pack, and that's where we get performance.


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