Churchouse Letter
February 2016         by Peter Churchouse

The Last of the Seven-Percenter’s

In all the chaos of current markets, this is an investment bright spot...

I've long been cynical about the prospects of this country.
But I think the tide is set to turn in 2016, everything is in a place for double-digit upside.
Although it's an EM, it doesn't have all the EM baggage we're so familiar with.

The year was 1977 and it was my first trip to India. The assignment: to undertake a small survey for the World Bank of conditions in the slums of East Calcutta.

The flight from London to Calcutta took a little over two days. It involved two, or was it three, unscheduled stops. I do remember one of them being in Dubai. My plane kept breaking down. Fortunately, it remained in the sky when it was supposed to.

I thought I’d seen it all. For more than three years, I’d travelled through more than 25 countries in Africa.

I’d seen first-hand the dreadful living conditions in the slums of Nairobi, Lagos, Kano, Kisangani and Bangui.

I was wrong. Nothing had prepared me for what I was about to see in this part of the world.

East Calcutta was an utterly desperate place. Even now, I recoil at my memories of the sights and smells. There was a level of poverty that I had never seen before, or witnessed again.

I spent a lot of time walking among ramshackle workshops and factories, speaking to workers, owners and families. Friendly people… in abject poverty.

Whole families, by the dozens, were living under four-square-metre pieces of canvas or corrugated iron, sleeping in lean-tos at the rear of workshops, cooking fires out in the open. Mud and dust everywhere, no running water or toilets to be seen. Sewage simply flowed through the dirt streets.

How people managed to maintain their brightly coloured saris, white shirts and well-manicured hair, was a mystery to me.

Just three weeks there gave me enough stories and memories to last a lifetime. I could regale you with 25 pages of colourful prose on the subject.

But I won’t.

I have not been back to East Calcutta since. My wife Gabrielle will tell you I came back from my three weeks there a different person. Experiencing first-hand this kind of abject poverty changes you.

During my visit, I was lucky enough to stay at the Bengal Club. It was a crusty old remnant of the Raj.

Entering its grand wooden doors was like taking a step back to the mid-19th century. Although the British had long gone, this bastion of British colonialism endured.

In the evenings, after dinner at the Club I would take a quiet wander around the streets of central Calcutta.

It was tricky. Street lamps were few and far between. The pavements were covered with sleeping bodies.

One evening a young chap fell in alongside me and began chatting. He wasn’t begging (which was more typical). He spoke well and told me he worked in an office job not far away.

He invited me home to meet his family. It was about 10pm. I confess I was a bit nervous about venturing too far from the Bengal Club. His home was just 200 yards away, he said.

We crossed the street and walked along the facade of a very grand, stone colonial building. It looked as though it might have been a government headquarters back in the 19th century.

Halfway along the side of this building he stopped and pointed to a narrow set of steps that descended below the foundations. What I was about to see amazed me.

The entire area beneath the building had been dug out between the supporting piles and walls. There was a maze of narrow corridors, cubicles and rooms made of tightly packed clay soil. The ceiling was so low I had to bend down to move through this underground network.

I followed my friend through various twists and turns, past curtained-off cubicles, until we finally came to his home.

His cubicle was about 15-feet deep by 10-feet wide, and about 5-feet high. The back section was covered in mattresses and curtained off. This was the sleeping area. Two little kids were fast asleep inside.

The clay walls and floor were like polished concrete. It was immaculately clean and tidy, and surprisingly comfortable.

This was his home. A small room inside this labyrinth of corridors, carved from the soil beneath a grand old 19th-century colonial building.

I was introduced to his wife, who proceeded to make a delicious cup of tea.

We sat and talked about the problems of the world, life in Calcutta, his job, and his aspirations.

There was no electricity, no running water and no sanitation. But the whole place was serene, well ordered, and beautifully clean. A well-organised micro community within the chaos of Calcutta.

I must confess, whenever I complain about the petty nuisances in life, it is this memory that puts things in perspective. This man had almost nothing, but he did have generosity and kindness.

With a population of just over 1.25 billion people, India is the second most populous country in the world and the most populous democracy in the planet.

Hindi is the official language of the government, spoken by 41% of the population. English is widely used in both business and government, although each state and union also have at least one additional official language.

India has given birth to four major world religions; Hinduism, Buddhism, Sikhism and Jainism.

In the early 18th century European trading companies, including the English East India Company began arriving in India at the same time the Mughal Empire was dissolving.

By 1820 the East India Company annexed or subdued most of India, marking the beginning of India's colonial period.

The East India Company was dissolved after the Indian Rebellion of 1857, leading to Britain instituting direct administration of the country.

After World War I, many Indians pushed for self-rule pressuring British authorities through a nonviolent movement of non-cooperation largely under the leadership of Mohandas Gandhi.

India gained its independence in the 1947, although it was bittersweet as it happened during the partitioning of India into the Dominion of Pakistan (Pakistan and Bangladesh) and the Union of India. The Union would go on to become the Republic of India in 1950 with the ratification of their constitution under Jawaharlal Nehru, India's first Prime Minister.

Over the years, I have been back and forth to India on business numerous times.

In the mid-90s, the bank I worked for managed to raise capital for what I think was India's first offshore convertible bond. For the Taj Hotels group. We recruited highly skilled and educated analysts to “export” for our research department. A local team to research the local markets was established.

I made extremely good returns in the fledgling India-listed property stock sector in my fund management days. It is still a very small sector given the size of the overall real estate market.

Today we are personally invested in technology venture capital there in the real estate space. More of that at another time!

For many years, India massively lagged behind its huge northern neighbour China. China has had by far the greater airtime on the world investment stage for the past 30 years.

While China embarked on a huge, centrally orchestrated mass-transformation of its economy and social system, India simply lumbered along like the thousands of cows on its streets.

Change has been much slower in coming to India than China.

But it is happening. China is slowing, and now India is forging ahead in growth and investment. It needs to.

Analysts and observers are naturally drawn to making the “compare and contrast” analysis between China and India. These two countries together make up 36% of the world’s 7.3 billion population.

I don’t want to go down that route now. However, I will make one overarching observation that I think explains the different paths and states of development of these two giants.

It is called democracy.

China is a dictatorship, an autocracy, where total control is exercised from the centre by a group that calls itself the Communist Party – a party that is communist only in name these days. But an autocracy, make no mistake about that.

When China wants to do something, it simply decrees it and it gets done.

If we want a railway line to link a city in the west of the country to a coastal port in the east, we just mobilise 100,000 workers, wheel barrows, shovels and bulldozers, and get on with it. That is how China managed to develop industry, infrastructure and urban development at an unprecedented rate and scale.

China doesn’t suffer tedious parliaments, quarrelsome legislatures, a divided congress, or pesky environmentalists.

Decide what you want to do. And dictate that it gets done.

India does not have such luxury. It is a democracy. As a result it suffers from all the problems of getting things done that democracies everywhere face. Even more so given the sheer dysfunction of India’s bureaucracy.

Ask anyone who’s ever had business dealings in India about the bureaucratic issues they face and it’s likely you’ll be in for a long conversation.

The situation is beyond painful. Back in 2012, it was ranked the worst in Asia by PERC (a Hong Kong-based political and economic risk consultancy) in terms of bureaucracy. And, believe me, Asia has plenty of competition in that arena!

Take Indian Railways, for example, the state-owned company administering and managing India’s 41,000 miles of railway routes. (The circumference of planet earth is only 24,000 miles!)

It’s one of the world’s largest employers with 1.4 million employees – that’s 100,000 more than the Indian Armed Forces.

Well, it took 18 months of decision-making to resolve the thorny issue of whether or not the mugs in the washrooms of second-class sleepers should be attached to the wall by chains, according to a recent Financial Times report.

With regard to the country’s legal system, India enjoys a common law system inherited from British colonial rule. But it is notoriously slow, encumbered by absurd amounts of red tape. Cases can take years to get to court let alone get resolved.

Companies, governments and all manner of public agencies launch legal cases at the drop of a hat knowing full well that nothing will happen for years.

What better way to stall a business deal, or public sector initiative than to launch some intricate, often dubious legal claim that you know will take years to get resolved, if at all?

When it comes to bankruptcy, proceedings are even more painful. According to the World Bank, winding up a company in India takes more than four years.Roughly twice as long as China. And asset recovery is just 25 cents on the dollar.

There are a multitude of laws that govern insolvency, plenty of which do not favour the creditor at all.

Some laws prohibit even taking legal action against the defaulting party until a restructuring plan is in place. This is something a defaulter isn’t in a rush to do. Plenty will just start another business under a relative’s name and funnel off their existing business into the new one.

A new bill proposed by India’s finance ministry for comprehensive bankruptcy reform in November should help. Although, not surprisingly, it has been delayed.

There’s no denying it, emerging markets are HATED right now. We talked about this space in our October 2015 edition of The Churchouse Letter – A Universally Hated Opportunity.

Readers may recall that we selected what we believe to be the best broad EM play, the Buy Your Subscription to The Churchouse Letter Today to Find Out!.

But as for when to take advantage of them we said:

“[Don’t] pull the trigger on a broad re-entry into global emerging markets just yet… It is hard to be convinced that markets have hit a bottom, and that total capitulation is at hand…. There is a lot of risk in financial markets right now. Those risks seem to be rising not falling…

“We hold on to our cash, and position whatever investments we have conservatively. There is no need to rush into anything much right now. Our strategy is to identify some of the themes and investments we want to be focusing on – when the time is right.”

MSCI’s Emerging Market Index has fallen by more than 15% since mid-October. Brazil is down 25%, China down 20%, Russia down 20%… it’s ugly, even by EM standards.

But more importantly, our low volatility ETF has outperformed the regular iShares EM ETF by nearly 3%...

On a longer timeline, it’s just as bad. Just look at Figure 1. EMs have lagged global equities by nearly 57.5% over the past 5 years.

MSCI World vs MSCI Emerging Markets 2011-2016

And 2016 hasn’t been any better. EMs were down as much as 13% by mid-January to finish the month down 6.5%.

I know we keep reminding our readers that not all emerging markets are the same – they are not all turkeys, as our Publisher and Head of Research Tama is fond of saying.

Our top EM picks, the Philippines and Vietnam, have outperformed broader EMs by 6% and 11%, respectively, over the past 12 months. (On the flipside, Turkey, no pun intended, has underperformed by about 9%.)

While we make the point that not all emerging markets are the same, it is true that many do share one of two characteristics...


What two features do emerging markets share that happen to be the reason behind their underperformance?

And what makes India stand out?

Purchase your subscription to The Churchouse Letter and discover how to take advantage of the opportunity this market presents us.

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