Investor conundrum: India's Premium or China's Discount?

The Indian election is in full swing, with 960 million voters going to the polls. Prime Minister Narendra Modi looks set to be returned for a third term, having presided over an astonishing economic expansion that saw India’s economy grow 7.8% in 2023*.

Investors in the Indian stock market have reaped the benefits. The average India fund was up 17.2% in 2023**, capping an outstanding run of performance. It is the top-performing sector over three years, with the average fund up 57%**, higher even than the headline-grabbing technology sector.

The contrast with China couldn’t be more stark. China has been a dismal place in which to be invested. It is the worst performing sector over one and three years**. 2023 was particularly grim, with the average China fund falling 20.2%**.

Please remember that the value of investments will fluctuate and returns may be less than the amount originally invested. Tax treatment depends on your individual circumstances and tax rules can change. Chelsea does not offer advice and, if you are unsure of anything please contact an expert adviser.

China’s ‘ugly’ economy

China’s problems have been well flagged and there are few signs of a resolution. Xavier Hovasse, head of emerging equities at Carmignac, says: “The top down story for China is quite ugly. The property market is a disaster; they have over-built and inventories are very high. The population is shrinking; while data is difficult to obtain, it seems that the number of babies born has shrunk from 18m to 10-11m.”

The country has struggled with persistent deflationary pressures. Investors had hoped for a boom in consumer spending when the country emerged from Covid lockdowns, but this has yet to materialise. Chinese consumers have built up savings, but don’t want to spend them. This has weighed on economic growth.

At the same time, investors have become increasingly disturbed about the geopolitical situation in China. There are concerns over its territorial claim to Taiwan, and a full-scale invasion remains a possibility. China has also put itself on the opposite side of the war in Ukraine. Relations with the US continue to be fractious, with direct consequences for Chinese businesses as they are shut out of supply chains and valuable markets.

Cheap versus expensive?

The dilemma for investors is that Chinese markets are very cheap, and Indian markets are very expensive. The diverging fortunes of the two Asian superpowers appear to be fully reflected in prices.

In the very short term, performance has started to flip, with Chinese funds around 9% ahead of Indian funds over the past three months**. The catalyst is unclear, but may have been due to slightly improved economic data from China in the first three months of the year.

Asia and emerging market fund managers are showing increasing enthusiasm for China. Jonathan Pines, manager on the Federated Hermes Asia ex Japan fund, says they have moved from a 2% overweight position in China last year, to an 18% overweight position today***.

He says: “While the news isn’t great, it hasn’t got much worse. There is a situation now where there are a number of household name companies, trading on very low valuations. And if you’re willing to look further afield, there are stocks trading at around three or four times their annual earnings with 100% of their market capitalisation in cash. There is a huge opportunity here.”

He points to companies such as Tencent, which have a pipeline of growth every bit as impressive as some of the US social media companies, but are a fraction of the price. “It is symptomatic of what is going on in China. Everything has been marked down, including the best stocks.”

Xavier Hovasse has been overweight China in the group’s emerging market fund for the past few years****, which, he admits, has given him some grey hairs. He says the Chinese market is very inefficient, which throws up some real stockpicking opportunities. Companies will be sold off to very low levels, and can then bounce very quickly on the slightest change in sentiment.

Jonathan agrees that when companies are trading very cheaply, it doesn’t take very much to make a significant difference. Global investors have been very underweight China and so the smallest positive sign can have an impact. This is what has been seen over the past few months.

India: a long-term plan?

On India, Xavier says: “The market is very expensive, but expensive markets can get more expensive. We still have a significant allocation to India. On some small and mid-cap companies, there has been excessive enthusiasm, but the growth rate is very good, and very healthy. The balance of payments situation in India is good, and the current account deficit is low.”

He says the government is very pro-business. It has brought in a raft of initiatives to encourage global companies to set up manufacturing there and companies such as Apple are ramping up production.

What should investors conclude from this?

India is probably the better long-term market, with a stronger pipeline of growth. Its companies are better governed and it doesn’t have the same geopolitical risks. Its political stability – likely to be confirmed by the upcoming election – is an important advantage over China.

That said, Chinese markets are now so cheap that they could be in line for a significant rally. There are signs that sentiment is improving and many fund managers are positioned for a turnaround. It is higher risk, and there are longer-term problems, such as geopolitics and the property market, but the potential for short-term returns should not be sniffed at.

Investing in a generalist Asian or Emerging Markets fund manager is the safer option. They can look at the balance of opportunities across both markets and decide which is the best option for long-term returns. The Fidelity Asia Pacific Opportunities fund could be a good option, with an experienced manager and long-term track record.

For broader exposure, French group Carmignac have one of the largest and most experienced analyst teams in the market. The FP Carmignac Emerging Markets fund invests in 35 to 55 larger companies across emerging markets and has a flexible approach.

For those with confidence in their convictions, a single country fund is a higher risk, but potentially higher reward option. For India, we’d choose the Goldman Sachs India Equity Portfolio fund, managed by a well-resourced and experienced team, based in Asia.

For China, we’d look at the FSSA All China or FSSA Greater China Growth funds. These funds have built a good track record, but – importantly – have strong risk management, which is vital when navigating these appealing but volatile markets.

*Source: IMF, World Economic Outlook, April 2024
**Source: FE fundinfo, data at 3 May 2024
***Source: Federated Hermes, 1 May 2024
****Source: Carmignac, April 2024

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.