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Modi-nisation

If Narendra Modi really can modernise India, that would be great for equities the emerging world over
June 13, 2014

Can the election of Narendra Modi as India's prime minister kick the emerging markets equity indices out of the funk into which they sank when investors grasped that China's economy would not grow by 10 per cent a year forever? Yes and no.

No, because - actually - these indices have already emerged from their grouchiest mood anyway. That particularly applies to India's equities. Starting last August, when it became clear that Mr Modi's BJP party had a real chance of winning this spring's election outright, the main index of the Bombay Stock Exchange has surged more than 40 per cent.

But the 'yes' reason is far more important if you reckon that Mr Modi's election could do for India what Deng Xiaoping's grasp of the Communist Party leadership in the late 1970s did for China. Okay, that's almost certainly an exaggeration, but Mr Modi marketed himself on a ticket of economic growth and the prize of India's modernisation at a Sino-like pace is immense. After all, India's scope to catch up with its massive eastern neighbour has widened hugely since Deng's reforms began.

According to World Bank data, back in 1980, China's per capita output still lagged India's - $193 a year compared with $271. Fast forward 32 years and China had made it to middle-income status with per capita GDP of $6,091. Meanwhile, India's brand of messy, quasi-democratic, overly bureaucratic, rather corrupt governance was yielding just $1,503 per person. So even raising the long-term growth rate by a couple of percentage points spread across 1.2bn people - and a population growing faster than China's - could generate the income and the company profits that would have investors the world over salivating.

As to the likelihood of India's long-term growth rate (5.5 per cent a year since 1980) getting closer to China's (11.4 per cent), that's mostly guesswork. Yet, clearly, Mr Modi comes with a good CV. His election platform was based less on the Hindu nationalism that brought him to prominence and more on delivering the economic competence that India so badly needs. During the 13 years - 2001 to 2014 - that he was the chief minister of Gujarat, the state consistently generated growth well ahead of India's average. For example, in the six years - 2005 to 2011 - Gujarat moved from being India's 18th richest state (ie, almost bottom of the pile) to 12th. True, it is often difficult to extract the substance of what Mr Modi's leadership achieved for Gujarat from his relentlessly upbeat PR machine. Nevertheless, four terms as the boss of Gujarat followed by a landslide general election win based on upscaling Gujarat's success to the whole nation implies that Mr Modi has done more right than wrong.

If Mr Modi's way of running India turns out to be more 'chief executive surrounded by capable technocrats' than the feudal style of the Nehru-Gandhi dynasty, that would please investors, too. Not that I'll be rushing to fine-tune the Bearbull Global Fund with a holding in an Indian equity market-tracking exchange traded fund (ETF).

Of course, there are such things. For example, within Deutsche Asset Management's db x-trackers range of funds there is one (code: XNIF) that tracks the 'Nifty 50' index of top Indian companies (which includes well-known names such as Cairn India, Hindustan Unilever, Infosys and Tata Steel). Alternatively, another tracks the much wider MSCI India index (code: XCX5).

Both these ETFs use 'indirect replication' to track their chosen index - effectively they have a continuous bet with a counterparty to ensure that they 'win' if the market rises and 'lose' if it falls. The theory is sound and indirect replication can be the best way of tracking a more obscure index. But it usually comes with a wider tracking difference than the alternative, which is to buy an appropriate weighting in all of the stocks in an index (direct replication) - and don't I just know that.

That's a reference to my miserable experience to date from holding an ETF from Societe Generale's Lyxor stable of funds that indirectly replicates the CSI 300 index of stocks listed on China's Shanghai and Shenzhen stock exchanges (code: CSIL). This fund was launched at the start of October since when the CSI 300 has fallen 11.4 per cent. Factor in tracking difference - the gap between index and fund performance that could be calculated in advance - plus tracking error - the shortfall that couldn't; then add in currency movements (China's yuan has been weak against the dollar) and the fund's net asset value has dropped 16.5 per cent. Worse, the London-listed ETF is priced in sterling. Adjust for changes to the sterling/dollar rate and the fund's sterling value has fallen 20.8 per cent. I bought a little after the launch, so losses to the Bearbull Global Fund are 'only' 18.3 per cent.

True, I went into the CSIL fund knowing the risks, but reckoning it was the best - or 'least bad' - way of getting more exposure to the liberation of Chinese consumer spending. That logic may hold good and the currency losses can be reversed. Still, I get the feeling that I'll always be playing 'catch up' with this one. Even so, my only plan for the global fund's exposure to emerging markets is to wait for mean reversion to work its magic - although if Mr Modi could work a little of the same, that would be great.