2023

Australian domiciled investors seeking diversification by investing abroad to gain exposure to different economies and currencies through their listed companies on overseas equity markets. Given their level of knowledge of foreign companies is generally lesser than companies listed on the ASX, this task is generally outsourced to an active manager, focused on outperforming an Index like the MSCI All Country World Index (ACWI) or an ETF seeking to replicate the performance of this or similar index.   Source: MSCI Observing the significant weight to the US market in the ACWI, most investors who have a balanced, growth or high growth risk profile, tend to have significant exposure to Australian equities and US equities in the growth component of their diversified portfolios. The Australian component is largely due to home bias and a taxeffective dividend structure, whilst the US component is largely a legacy of the strong performance of the S&P500 over the last 15 years since the GFC.  Active vs Passive For active minded investors the focus is generally on outperforming the MSCI ACWI through portfolio construction. If this is outsourced to a group of asset managers who are focused on the appropriate regional allocation and stock selection, then as an investor you are usually looking for outperformance which correlates with the philosophy, style and process of the asset management firms selected. Passive investors generally focus on keeping costs low and hold a view that a market-cap weighted index is hard to outperform. They may also seek to implement their own views through smart-beta or thematic ETF’s.  For the purposes of this note, we focus on actively minded portfolio constructors, who seek to create a portfolio that can outperform the ACWI.  Building a Global Equity Portfolio for Outperformance One of the key thematics being explored by investors constructing exposure to global equities is the performance of listed companies in emerging market (EM) countries. Today most investors continue to allocate to EM managers, benchmarked to the MSCI EM, as a ‘satellite’ option to generate greater outperformance. This is based on the belief that the expected GDP growth of these EM economies as an aggregate is usually forecast to exceed growth expectations of developed market (DM) economies. However, the “last period bias” of many investors will leave most feeling that EM has always underperformed expectations, particularly over the past 15 years. Over this period, EM as an asset class have had many false starts, luring investors to allocating an overweight position relative to the (EM weight in the) ACWI, in an effort to generate outperformance.   The chart above though indicates that there can be periods of significant outperformance (i.e. 2003-2008, where specific EM exposure can add value to a portfolio, relatively to purely DM only portfolio. 2003-2008 was a period where the USD fell from a peak (2003) and led to investors (particularly from the US) to allocate to EM in a ‘bucket’ type approach, using broad based EM managers to gain exposure to strong economic growth and appreciating currencies in these economies.  Fast forward to 2023… Post 2016, a period of de-globalisation emerged which has led some investors away from bucket style allocations to broad EM strategies, as economic and market performance has shown greater dispersion due to protectionism, trade-wars, the pandemic and geopolitics. The economic and equity market performance of regions like China, Turkey, Brazil, Middle East and Russia have shown great dispersion at times.   Under these circumstances, diversity sought through correlation benefits can be lost in a de-globalised world when aggregated strategies are considered over more less correlated themes / regions. The orange bars reflect the falling correlations over the last three years, as opposed to structural correlations measured over the last 20 years (blue bars). This perhaps points to a more ideal environment to select a region with strong structural growth, with correlation benefits when building a more optimal diversified portfolio. Quite often investors seek to invest in the lowest standard deviation outcomes across all asset classes, creating the potential for “over-diversification” and therefore losing the benefit of low correlation when building portfolios. This can create correlations which always seem to pop up when least desirable. EM investing EM funds are investment products, but by no means could this product be considered an asset class. There is no familiar trait from one EM to another and it is not homogenous. The idiosyncrasies of growth and its sustainability, politics, risks, levels of state ownership have far more dispersion than experienced across DM economies. This dispersion has led EM in aggregate to disappointment for investors, despite clear evidence of strong GDP growth in some of these economies.  The growth across various countries within EM has been inconsistent due to the cyclicality of economies influenced by commodities i.e. Brazil, South Africa, Russia, Middle East or reliance on exporting (Mexico, South Korea, Taiwan). Additionally, GDP growth doesn’t always correlate to EPS growth. Quite often, listed EM companies do not provide a true reflection of the local economy, which is driven more by its MSME’s that remain unlisted or the domain of local investors due to lesser regulation, lack of need for capital, compliance burden and lack of liquidity for larger institutional investors. Larger and more liquid stocks which tend to be the domain of EM funds can contain more state-owned enterprises, which can be inefficient and poor allocator of resources as well as larger more mature growth businesses, which have already experienced their S-curve. Why do we invest in EM Typically investors seek EM exposure in an attempt to access greater earnings growth, which is diverse to sources of earning growth in DM. Alpha attainable from investing in these markets should also be more abundant as you are ‘digging deeper’ into less efficient markets, with less broker coverage. However, investing in EM as an asset class has ended up being a high beta play on investing in DM. Inevitably the exposure fares worse in downturns as US investors (the home of capital) repatriate funds during a flight to safety. As recession fears increase, commodity and export driven economies tend

Recently a report was released from Hindenburg Research which insinuated logic for shorting the stocks within the Adani Group. This Report was released last week and has had an immediate adverse impact on the share prices of the Group companies as well as other businesses which may have some linkage to the Adani Group. As a result of the report, the seven listed companies within the Group have lost US$48bnin market value. The report flags concerns about the Group’s debt levels, market manipulation, accounting fraud as well as the use of tax havens. The report claims that there is a web of family controlled offshore entities in tax havens from the Caribbean, Mauritius and the UAE which were used to facilitate corruption, money laundering and taxpayer theft, while siphoning money from the Group’s listed companies. The MSCI India weighting of these companies is collectively 5.75%. The MSCI is currently seeking feedback on whether they will need to take any action. Whilst it may adopt to do nothing post feedback, another option is to exclude the Adani Group and associated companies from the index due to excess volatility.   The Adani Group has refuted the allegations made in the report, stating that it was published on the 24th of January 2023, without making any attempt to contact the company or check facts. They have claimed that the report is a “malicious combination of selective misinformation and stale, baseless and discredited allegations that have been tested and rejected by India’s highest courts”.  It was also stated that the report intentionally aims to undermine not only the Group’s reputation, but also to damage the upcoming US$2.5bn follow-on Public Offering from Adani Enterprises, which was set to be the largest FPO ever in India. The anchor investor component of the offering was oversubscribed, but the market premium demanded prior to the Hindenburg Report has now less than halved. Adani Enterprises have stated that there will be no change to the schedule or issue price of the FPO (27th -31st January 2023).  The Adani Group has risen to prominence over the last 3 years, but was founded in 1988. The company is head quartered in Ahmedabad and was founded by current chairman, Gautam Adani. The Group was founded in 1988 as a commodity trading business, with the flagship company Adani Enterprises. The Group’s businesses include port management, electric power generation and transmission, renewable energy, mining, airportoperations, natural gas, food processing and infrastructure.  In November 2022, Adani Group market capitalization reached top US$280 billion, surpassing Tata Group. The group is responsible for the Carmichael Project in Queensland, which is the operation of a coal mine, producing its first shipment in December 2021.  The Adani Group Companies are approximately 6% of the MSCI India, which is our benchmark.  India Avenue Equity Fund and India 2030 Fund have no exposure to the Adani Group at this time and thus are not affected directly by the fall in value of the shares of the Group. However, generally it has had a negative impact on market sentiment. This can occur as investor try to assess the short-term impacts on businesses which may be linked. We expect trading in these companies to be volatile and difficult to predict, given the Hindenburg Report and the upcoming FPO for Adani Enterprises. Rather than speculate, we prefer to stay on the sidelines and observe market action. We don’s see this causing any systemic issues related to Indian equities for investors. However, there will be increased market volatility, particularly for the Adani Group companies (7 listed) and associated companies like Ambuja Cements and ACC in the short-term. The strength in the AUD since October 2022, relative to the INR and the general market volatility caused by the Hindenburg report may present an opportunity for long-term investors seeking to invest in the India growth story. However, this note is not to be taken as advice. You will need to speak to your financial adviser on your existing portfolio and individual circumstances.  We intend to keep you updated with further relevant information as and when it becomes available. Our Disclaimer: Equity Trustees Limited (“Equity Trustees”) (ABN 46 004 031 298), AFSL 240975, is the Responsible Entity for the India Avenue Equity Fund (“the Fund”). Equity Trustees is a subsidiary of EQT Holdings Limited (ABN 22 607 797 615), a publicly listed company on the Australian Securities Exchange (ASX: EQT). The Investment Manager for the Fund is India Avenue Investment Management Australia Pty. Ltd. (“IAIM”) (ABN 38 604 095 954), AFSL 478233. This publication has been prepared by IAIM to provide you with general information only. In preparing this information, we did not take into account the investment objectives, financial situation or particular needs of any particular person. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. Neither Equity Trustees, IAIM nor any of their related parties, their employees, or directors, provide any warranty of accuracy or reliability in relation to such information or accept any liability to any person who relies on it. Past performance should not be taken as an indicator of future performance. You should obtain a copy of the Product Disclosure Statement before making a decision about whether to invest in this product.  The India Avenue Equity Fund Target Market Determination is available. India Avenue Equity Fund’s Target Market Determination is available on our website: www.indiaavenueinvest.com/our-fund. A Target Market Determination describes who this financial product is likely to be appropriate for (i.e. the target market), and any conditions around how the product can be distributed to investors. It also describes the events or circumstances where the Target Market Determination for this financial product may need to be reviewed.   Click here to view the full article