The adage that "investing in the right industry is at least as important, if not more, than choosing the right investments" holds true in India as much as it does in any other country.
An investor needs to invest in industries that generate better returns relative to others and then needs to find specific assets within the industry that are available at attractive valuations. Regulatory conditions, demographic trends and inter-linkages between sectors are some of the drivers of growth and consequent investment attractiveness.
For instance, the recent decision on the localisation of data in India creates an investment opportunity for data centre infrastructure investors and ancillary industries. Assuming regulations are implemented and enforced credibly, tremendous infrastructure in data centres will be required to localise data.
The average monthly mobile data consumption per user in India increased by 15 times from the end of 2014 to the end of 2017 to over 4GB. The number is expected to more than triple in the next five years. Given this is mobile data consumption, if one were to add other sources of retail and industrial data consumption, one gets an idea of the vast data storage need in India.
The exponential data growth creates an opportunity for investors in sophisticated and large-scale data centres. Data centre investments will also imply opportunities in the supporting ecosystem of real estate and power supply. Real estate firms that can provide the vital data centre infrastructure become an attractive proposition as do power producers who can provide the high-power consumption needs of data centres.
The entire ecosystem benefits and creates investment opportunities for many investors. Identifying inter-linkages within industries is important for specialised investors. The impact that regulations can have in creating value across a chain of sectors is worth keeping in mind.
Changing consumption patterns and trends in income will be another significant driver of industry attractiveness. For an investor looking at sectors with long-term secular trends, watching how non-food consumption is changing with rising incomes should provide valuable insights. Discretionary consumer space is where a large part of the action should be expected given gradually rising incomes.
In the Boston Consulting Group report titled "The New Indian: The Many Facets of a Changing Consumer", Abheek Singhi, Nimisha Jain and Kanika Sanghi point out a category that takes off for discretionary consumer products above a certain income level. This category includes industries such as entertainment, non-essential food consumption, high-end clothing and cosmetics. Capturing the upside in sectors that will benefit from rising incomes is crucial for investors looking to ride the India growth story.
Identifying attractive industries from an investment perspective is the first vital step. Industries with the correct growth dynamics help narrow down the list of outperformers across sectors. Institutional investors can approach the potential attractive investment opportunities within the identified areas through a variety of strategies, the key driver being the acquisition of the assets at attractive valuations.
Accessing opportunities through investments in the listed equity markets is one potential path if pockets of opportunities exist. Alternatively, investors with a long-term focus can create value through accessing assets through private markets, if they provide significantly lower valuation multiples due to both smaller size of businesses and current valuation multiples in the public equity markets.
Choice of the industry holds the key regardless of whether investors are focused on infrastructure businesses or consumer-facing sectors. While fundamental valuations are the absolute gospel for investing, favourable industries do provide a helpful "tailwind" for investors.
An analysis of annualised 10-year returns for S&P 500 sectors (represented by SPDR Exchange Traded Funds XLU & XLF as proxies) shows how utilities were able to deliver slightly higher annualised returns at 8.81 percent over financials (which faced significant regulatory hurdles over the last decade) at 7.34 percent.
The critical question investors must be asking of financials today is whether a less onerous regulatory regime is in the offing, thereby boosting returns over the next decade, or whether the new age fintech firms will create barriers to higher profits. The same rules apply in an Indian context. For patient investors looking at decade-long investment horizons, industry analysis can add significant value.
(Taponeel Mukherjee heads Development Tracks, an infrastructure advisory firm. Views expressed are personal. He can be contacted at email@example.com or @Taponeel on Twitter)