2015

The Indian Rupee (INR) has origins back to 6th Century BC. More recently, India’s currency was on parity with the US Dollar at the point of its independence in 1947. Since then, external borrowings to finance welfare and development led to a devaluation of the Rupee.A fixed rate currency regime was put in place from 1948-1966 pegging the Rupee at Rs4.79 to one USD. Post wars against China and Pakistan (which needed funding) saw the peg reset to Rs7.57. From 1966-1991 the Rupee continually devalued due to high inflation, low growth and low levels of foreign reserves, ending with a peg level of Rs17.90. 1993 saw a significant change, with the currency being free-floated leading to speedy depreciation to Rs31.37. Since 1993, the currency has continued to witness steady depreciation, trading recently at just over Rs65 per USD. However, a free float currency has led to India becoming more competitive which significantly increased foreign investment inflows and boosted economic growth.  VOLATILE CURRENCY SINCE FREE FLOAT The INR’s volatility is approximately 8.3% p.a. (against the USD) when measured as annualised volatility of monthly percentage changes over the past 25 years. It is even higher against the AUD at 10.9% p.a. Volatility heightened during 2012-13 as inflation rose, deficits at both the current account and fiscal level increased and economic growth slowed through poor execution by the prior Government. As investors withdrew their allocation to India over this period, the currency experienced significant weakness.   INDIA’S CENTRAL BANK AND MODI’S WIN Since free float, the volatility of the Rupee reflects high inflation, low levels of foreign reserves and a lack of investor confidence in the economy. More recently the RBI, under the guidance of Raghuram Rajan, has had a stabilising effect. Interest rates were raised, not only in response to higher inflation, but making it expensive for speculators to take a short position. Additionally, post the election win in May 2014 by the BJP Party, led by Narendra Modi, the India story has been promoted heavily, encouraging more positive sentiment towards investing in India. In fact the Rupee has been relatively strong against most other currencies, with the exception of the rate-hike fuelled USD (and the CNY which is pegged to the USD). As economic growth has reaccelerated, inflation has fallen and foreign reserves have been accumulated, the currency’s volatility has receded.   Chart 1: INR Performance vs Major Currencies/BRIC’s (May 2014-Oct 2015) Source: India Avenue Research, Yahoo Finance THE LAST 25 YEARS: AUD/INR Over the last 25 years the average rate of depreciation against the AUD has been 3.6% p.a. This equates approximately to the cost of hedging currency exposure to the INR for an Australian investor. Chart 2: AUD-INR Currency Movements (1992-2015) Source: India Avenue Research, Bloomberg Over the last 25 years the AUD has been strong relative to INR. Factors contributing to this have been: The Australian economy has been growing above trend since 1991 Structural demand for commodities, driven by China’s industrialisation Australia’s high relative yields (compared to other highly rated sovereigns) India’s structural higher inflation COST OF HEDGING INR EXPOSURE FOR AN AUSTRALIAN INVESTOR Typically the interest rate differential between Australia and India has varied over time. Over the last 15 years, Australia’s interest rates have also been higher in response to higher inflation. As a result funds have flowed into Australia as foreign investors from regions like Japan and more recently Europe and the US have sought to benefit from higher rates. Chart 3: AUD/INR Interest Rate Differential – Cost of Hedging Source: India Avenue Research, Bloomberg With Australian cash rates now falling to 2%, the interest rate differential to India is high compared to history. Thus the cost of fully hedging currency exposure to the INR is now higher at 3.5-4% p.a. From a US investor’s perspective the cost has been even higher over time and is currently approximately 7% p.a.The high cost tends to prevent investors from hedging their exposures or possibly avoiding exposure at all. Whilst India is likely to retain its status as a higher inflation, higher interest rate economy, there are other factors which can significantly influence movement of the AUD/INR cross. OUTLOOK FOR THE INDIAN RUPEE VS AUSTRALIAN DOLLAR Some of these factors below have been in play since 2013 as the AUD depreciated significantly and the INR started to stabilise: India’s growth likely to be well above Australia’s going forward (as forecasted by IMF) Structural demand for commodities falling due to weakening global growth India-Australia inflation spread likely to fall as infrastructure bottlenecks in India are reduced by its Government reform agenda Lower interest rates in Australia, leading to less foreign investment Additionally, it appears likely that demand for Indian assets will increase, given its appeal as a high growth region, with a stabilising currency, a build-up of foreign exchange reserves and the potential for sovereign risk rating upgrades from S&P, Moody’s and Fitch. INDIA AVENUE’S VIEW On a long-term basis the Rupee is one of the most undervalued currencies relative to purchasing power parity. The discount is largely reflective of a high inflation economy, which has eroded the purchasing power of its currency over time. [box] Going forward we expect that the Rupee will be a more attractive currency to own given that both growth assets and high yielding currencies will be heavily sought after, given their scarcity in a low growth/low inflation environment.[/box] We would advocate investors maintain an unhedged exposure to the Rupee, particularly from an Australian investor’s perspective. The Rupee also has a low correlation to commodity prices, providing good diversification, given the linkages of the Australian economy .   Chart 4: Indian Rupee: Diversifier for Australian Investors Source: Bloomberg, RBA, EIA, India Avenue Research   CONCLUSION When investing in the capital markets of a foreign country, currency exposure is always a significant component of overall return. However, exposure to foreign markets and their currencies can provide considerable diversification benefits and a much broader opportunity set. For Australian investors this has been particularly pertinent due

Consumerism can be defined as increasing consumption of goods and services being economically desirable. The belief being that increasing levels of spending, rather than saving, leads to a greater level of GDP. India has a significant opportunity in consumerism due to its demographic dividend and the emergence of its middle class as a consumer. In this note we illustrate the opportunity, which can be leveraged by companies operating in DEMOGRAPHIC DIVIDEND Figure 1: Population by age Source: populationpyramid.net The population profile of India provides significant insight into the opportunity available for businesses. Approximately 50% of the population is below the age of 25 and 78% is below the age of 45. This age structure creates a “demographic dividend” which refers to the fact that a substantial proportion of the population is working age (i.e. 15-64 is 65%) with the opportunity to be productive. However, a large population on its own does not create the opportunity for profit without focused policy and reforms, particularly to absorb a rapidly growing workforce. The Government of India understands the need for focus on education, healthcare and financial inclusion, particularly in Tier 2 and 3 cities. Critical in cultivating the demographic dividend, is the need to develop skills through better education, thereby improving productivity, given the expectation of a global shortfall in skilled labour. HOUSEHOLD SAVINGS RATE Figure 2: Indian Household Savings HOUSEHOLD SAVINGS RATE Figure 2: Indian Household Savings Source: tradingeconomics.com India’s household saving rate is over 30% of disposable income, which is representative of Asia’s cultural propensity to save in general. Contrast this to the savings rate of the US (4%), Japan (sub 1%), Europe (7%), UK (4%) and Australia (9%)[1] and it is easy to understand the potential consumption spending power of a youthful and vibrant India, particularly given the focus on job creation by the Modi Government. If oil prices continue to remain low and inflation recedes, it provides the opportunity for lower interest rates, which stimulates spending and credit growth. This is likely to benefit several consumption oriented companies over the next 3-5 years in particular. RISING MIDDLE CLASS According to NCAER, India’s middle class population by 2025-26, will more than double from 2015-16 levels to reach 114mn households or 547mn individuals. This is close to twice the population of the United States! The NCAER report also stated that whilst the middle class was only 13% of the Indian population, it in fact owned 49% of cars, 21% of TV’s, 53% of computers and 46% of credit cards. The report forecasts that the middle class would constitute 20% of the population by 2015-2016 and over 30% by 2025-2026[2]. In fact, according to Mckinsey Global Institute, middle and affluent classes in India will contribute 80% of total consumption by 2025, up from 25% in 2005 and 55% in 2015[3]. Projects like “Make in India”, where the Modi Government is focused on bringing manufacturing back to India through research and development and improving the ease of doing business for foreign companies, are likely to provide ample opportunity for job creation. A young, working age demographic, coupled with increased skilled employment creates a powerful tailwind for increasing consumption.  CONSUMPTION OPPORTUNITY India’s consumer market, buoyed by a strong economy, rising household income and socioeconomic forces, is likely to see the size of consumer spending increase from USD$1trillion in 2010 to USD$3.6trillion by 2020, according to a study done by Boston Consulting Group in 2012[4]. And this forecast was made prior to Modi’s election win! This presents significant opportunity for local and foreign manufacturers and retailers to benefit from increasing spending power. However, one of the battles for these companies is the requirement to re-brand their product base for the Indian consumer. Price is one of the key drivers of demand given much of India still remains rural and classified as poor. The product set needs to take into account limited supplies of electricity, water and other amenities as well as the high propensity to save. For example a washing machine manufacturer has to consider water shortage, cost of electricity, required usage and most importantly price point before considering the growth opportunity. Car manufacturers also face a significant opportunity given that the rising middle class is likely to consider a purchase of an automobile for the first time. Current two-wheelers dominate the market because of price point, fuel costs, traffic and space. However, given the right product and price point the opportunity remains significant for auto manufacturers, particularly local companies like Maruti Suzuki, Tata Motors, Mahindra & Mahindra and Ashok Leyland to name some. Other industries likely to benefit from the consumerism theme include Food and Beverages, Clothing and Footwear, Alcohol and Tobacco, Household Goods, Education, Transport, Communications Healthcare, Housing, Hotels and Leisure.  TECHNOLOGY AND SOCIAL MEDIA The rise of social media and technology has also had an impact on the Indian consumer to spend. Social media has benefitted companies to create greater brand awareness, particularly in Tier 1 and 2 cities where wealth is more significant and internet penetration is high.  INDIA AVENUE OPINION Consumerism is inevitable in India as trends towards urbanisation, increasing consumption and increasing employment take hold. Technology enhances the speed by which companies can penetrate households. This should be a strong driver of growth in India. It is our view that companies with the appropriate consumer preference awareness, price point and localised market knowledge are likely to benefit significantly from policy initiatives and reform such as GST. The potential for increasing earnings growth, given the tailwinds of spending power, youthful demographics and rising wealth through skilled employment, are mind boggling With consumption spending set to accelerate significantly, it is likely that a “virtuous circle” of efficiency, scale and profitability commences for companies catering for shifting consumer demands CONCLUSION The future appears bright for consumer branded companies operating in India who know their customer and can cater for changing tastes and preferences of a local customer base. However, the demographic dividend can pass India by if policy and reform agendas do not focus on

The hypothesis that locally domiciled Indian equity managers have greater insights into the microeconomic landscape for companies, via connectivity with local brokers, networks, and research needs to be tested.In this note, we seek to assess the performance of local India funds in comparison to foreign-based India funds. Most investors investing into India from overseas gain exposure to Indian equities via Foreign Funds, ETF’s or Emerging Market Funds. However, we feel active, regionally focused management can add significant value to an investors returns. Performance over a 10 year period We have compared performance over a 10 year period, using a year-by-year analysis from July 2004 to June 2014. For each period we compare the median achievement of both local funds and foreign funds.   Key Findings Local Funds outperformed Foreign Funds by 1.85% and the BSE 200 by 2.02% per annum over the 10 year period. This produces a significant compounded effect over time. Additionally local funds seem to deliver stronger returns in up markets due to their ability to identify a broader set of growth opportunities. We feel this advantage is driven by networks, contacts, local brokers and ability to invest in more mid and small cap companies. We accept that the median fund is not necessarily the investment experience of an investor. However, it presents a method by which to portray the average funds return. The significant dispersion of returns for local funds, given that there are significantly more local funds than foreign funds, means that strong due diligence in manager selection can pay handsome rewards through improve returns.   Conclusions It is our view that local investment managers present a strong choice for investors, given significant local insights, connectivity to markets and information and the ability to invest in lower capitalisation names due to generally lower AUM size. This allows investors to participate in the growth stories of India from an early stage when their return trajectory is far steeper. Our multi-manager philosophy ensures that the underlying investment teams managing the funds, remain the within the optimal selection set of India Avenue’s Investment Team at all times.

Corruption exists in India and is a problem which adversely impacts its economy. In 2014 India ranked 85th out of175 countries in Transparency International’s Corruption Perceptions Index.This was an improvement from a ranking of 94th in 2013. However, India is not the only large economy which ranks highly in terms of corruption, given China ranked 80th in 2013 and fell to 100th in 2014. A study on Bribery and Corruption in India conducted in 2013 by one of the largest global professional services firms Ernst & Young (EY)* , a majority of the survey respondents from PE firms said that a company operating in a sector which is perceived as highly corrupt, may lose ground when it comes to fair valuation of its business, as investors bargain hard and factor in the cost of corruption at the time of transaction. Corruption invariably increases transaction costs and uncertainty in an economy while lowering efficiency, by forcing entrepreneurs to divert their scarce time and money to bribery rather than production. It inhibits the development of a healthy marketplace and imbalances economic and social development by distorting the rule of law and weakening the institutional foundation on which economic growth depends. Causes of Corruption in India Excessive regulations, Complicated taxes and licensing systems, Numerous government departments each with opaque bureaucracy and discretionary powers, Monopoly by government controlled institutions on certain goods and services delivery; and The lack of transparent laws and processes. Corruption has an Impact! A November 2010 report from the Washington-based Global Financial Integrity** estimates that over a 60-year period, India lost US$213 billion in illicit financial flows beginning in 1948. Adjusted for inflation, this is estimated to be 462 billion in 2010 dollars, or about $8 billion per year ($7 per capita per year). India ranks 5th in the world in illicit outflows, and is the poorest country in the top-10 by per-capita GDP. The report also estimated the size of India’s underground economy at approximately US$640 billion at the end of 2008 or roughly 50% of the nation’s GDP.The previous administration began to beef up efforts to curtail trade mis-invoicing at customs two years ago, recovering nearly $400 million in additional tax revenue in two years. However, India has just scratched the surface at curtailing illicit financial flows. For 2015, the World Bank’s Doing Business Report^ placed India at 142 out of 189 countries that were ranked in terms of ease of doing business. India scores are low in the categories of starting a business, getting construction permits, paying taxes and enforcing contracts Fight Against Corruption Indian Prime Minister, Narendra Modi vowed that uncovering and penalising corruption would be a focus of his government when he won a landslide victory in May. As a result, businesses are taking this pledge seriously, by increasing their focusing on governance and compliance systems, improving their transparency to global investors and hopefully resulting in better valuations, coinciding with the positive sentiment and momentum on the Indian economy. Over the past few months, the World Economic Forum’s coalition against corruption has seen a significant uptick in interest from multinational companies with operations in India. 75 per cent of the 100-odd global firms that have committed to tackle the issue in their operations with the WEF, have a significant or growing presence in India, through direct operations, joint ventures and portfolio stakes. Six Indian firms being Infosys, Mahindra & Mahindra, Godrej & Boyce, Genpact, Wipro and Bajaj Auto are also part of the anti-corruption initiative. Actions Taken to Reduce Corruption Some of the actions considered to increase transparency include: Minimising the number of touch points with bureaucracy; Minimising the use of cash based transactions; and Adopting digital tools to remove official discretion. Importance of Corporate Governance in the Capital Market Good corporate governance standards are essential for the integrity of corporations, financial institutions and markets and have a bearing on the growth and stability of the economy. Over the past decade, India has made significant strides in the areas of corporate governance reforms, which have improved public trust in the market. These reforms have been well received by the investors, including the foreign institutional investors (FIIs).According to a World Bank study “Doing Business 2014”, India ranks 34th worldwide in terms of investor protection which is an important indicator of corporate governance across all countries considered^^. The enactment of the companies Act 2013 was major development in corporate governance in 2013. The new Act replaces the Companies Act, 1956 and aims to improve the standard of corporate governance standards, simplify regulations and enhance the interests of minority shareholders. The new Act is a major milestone in the corporate governance sphere in India and is likely to have significant impact on the governance of companies in the country India Avenue’s Value Add Corporate Governance and Corruption issues sometimes can be detectable through strong operational due diligence. However, on a large number of occasions it cannot be detected.Either way we feel the strong value proposition for India Avenue are the following: Connectivity through locally built networks of investment managers, brokers and other market participants Pure focus on India and its capital markets All assets are owned by India Avenue – so our dedicated team will monitor in real time Mandates will deal significant concentration in industry or over reliance in a single security *Bribery and corruption: Ground reality in India, Survey by EY 2013**Paper on Illicit Financial Flows, E.J. Fagan, Global Financial Integrity, May 2014^Doing Business Report, World Bank, 2015^^Corporate Governance in India: Developments and Policies, NSE India