Returning from a recent trip to India, Ingrid Baker, senior portfolio manager for Invesco Emerging Markets Class, maintains a cautious, long-term investment approach, with a 4.2% weighting in the country.
Baker, who co-manages the mandate with Jeff Feng, is part of the global select equities team with Invesco Advisers Inc., based in Atlanta, a subadvisor for certain Invesco Canada Ltd. funds.
“Of all the emerging countries,” says Baker, “India has a strong sampling of really high-quality companies, but unfortunately you really have to pay up for them.”
“India has such a great demographic profile, a young population, with 60% in rural areas. So there’s a whole story of income improvement, and the organic growth rate for that market is north of 5%”, Baker notes.
The investment approach for the overall portfolio looks for four key stock criteria – free cash flow, organic growth, return on capital and sustainable competitive advantage, or FORS for short.
The first is free cash flow, and the strategy looks for companies that can generate free cash flow on a consistent basis. Consistent free cash flow generation allows the companies to either reinvest back into the business, creating another stage of growth, or give it back to investors via buy-backs or dividends.
Organic growth is another stock characteristic. The team favors businesses that have long-term growth drivers that are not dependent on acquiring other businesses to grow. The focus is on companies that have the potential to organically and quickly compound their intrinsic value, “at the very least at mid-single digit rates,” says Baker.
Return on Capital is another criteria, seeking companies that can consistently generate high returns on capital over a full market cycle.
The forth criteria looks for companies with sustainable competitive advantage, and is the most important, according to Baker, who notes that the managers spend most of their analysis on this criterion. She believes it’s the competitive advantage that really supports the sustainability of free cash flow, organic growth and excess return on capital. Examples of competitive advantages include brand equities for pricing power, a wide distribution network, economies of scale, patents, and technological breakthroughs.
The team also looks at the quality of management, and checks that they are aligned with the investment thesis and the interests of minority shareholders. “We like it when management has real skin in the game,” says Baker, “because we think they are more likely to make capital allocation and operational decisions that will generate value for the long term for us.”
If a company passes this rigorous fundamental research stage but is trading at a premium to intrinsic value, it is put on a watch list. Market volatility or some event may bring the company’s price back to a level that make it an attractive buying opportunity. The investment team usually looks for a discount of about 20% to 30%, but will not sacrifice quality to get that discount, says Baker.
The philosophy of the fund is centered on a concentrated, high-conviction portfolio of approximately 50 names across all market caps. In general, the fund holds companies for a five to six-year period.
Currently, there are two Indian companies in the fund, with Housing Development Finance Corp. Ltd. (HDFC), among the top 10 holdings. HDFC is a financial conglomerate that owns a stake in HDFC Bank, the largest and highest quality bank in India, as well as life and general insurance, and other management assets. “I met with the company when I was there,” says Baker, “and life insurance in India has barely scratched the surface. The management is very innovative, there is a huge growth opportunity there.”
The Invesco team may be exiting the other holding in the fund, Zee Entertainment Enterprises Limited (ZEEL/NYE), a mass media company and television programmer, if the business doesn’t continue to meet the investment criteria.
Although Zee has the widest network in India, “what’s happening in this sector,” says Baker, “is that U.S.-based Netflix Inc., (NFLX), and Amazon.com Inc. (AMZN) are entering the market and competing with them. But I don’t think it’s an immediate threat because most Indian households only have one TV, so there’s always going to be a TV on, and then someone else will be using their mobile device to watch something.” She notes that Netflix and Amazon are priced more at a premium in India.
A name that’s on the watch list is Mumbai-based Hindustan Unilever Limited, an Indian consumer goods company, owned by Netherlands-based Unilever. “When I returned from India,” says Baker, “I was very impressed with Hindustan Unilever. “They are very innovative and were pioneers in selling shampoos and hair products in small packets to make it accessible and affordable to rural farmers and inhabitants.” In addition, the company is really on top of the shift in India, tailoring their products to different regions. For example, a big trend in India is the movement towards Ayurveda alternative medicine, and that’s one of their products. “The company has one of the best distribution systems in India,” says Baker, “but it’s trading at 54 times price to earnings, so it’s really expensive for us, but we are monitoring it closely.”
In positioning the fund, the major challenges that are factored in for India include ongoing infrastructure hurdles in the country and an upcoming political election next year.
For investors considering the mandate, “I think it’s for somebody who has a long-term view,” says Baker, “and is willing to stomach the volatility. It is more concentrated than most funds out there.”
