Sometimes, investment ideas are born out of a conversation between two friends at a spicy Indian buffet.
In January 2020, Manny Singh and Amit Anand, who became friends while working at the legendary hedge fund Tiger Management and its offshoot Axial Capital Management, were having brunch at the Bukhara Grill in NYC's Midtown East when their discussion zeroed in on the Indian stock market.
At the time, the US stock market had performed quite well, but a lot of the performance was due to multiple expansion instead of overall earnings growth, the duo believed.
"We said 'are there interesting growth areas of the world where there hasn't been as much multiple expansion,'" Anand said in an interview. "So what you are really paying for is earnings growth rather than this rush of cheap money that the Fed has created."
The answer for the duo was clear, Indian stocks and specifically Indian financial stocks.
India, which UBS projects will be the third-largest economy in the world by 2030 after the US and China, makes for an exciting investment case. Legendary emerging-markets veteran Mark Mobius is among the many western investors who are bullish about the Indian stock market.
"What's most exciting about India today is that it is a growing economy with really good demographics, where about half the population is actually under 30 years old," Anand said. "And it has really cheap data pricing. There's been a smartphone revolution with Reliance Jio launching 4G a few years ago and smartphone penetration has been quite high, with total internet penetration reaching about 30%, which is actually a lot of people given India's population."
Betting on financial stocks
The biggest beneficiary of this new generation of consumers and the burgeoning internet-tech revolution is the Indian financial sector, in his view.
"The Indian financial services sector has a moat around it because the regulator is so careful about who gets banking licenses. And India's had a bunch of big investor-run and investor-owned banks, and they don't face that much incremental competition," he said. "It's very different when it comes to online consumer companies, for example, that constantly need more capital because they have to outcompete each other."
As a result, India's internet and fintech revolution have allowed financial services companies to grow their already profitable businesses in a very cost-efficient manner.
Another reason that Anand and his partners chose to focus on financial stocks is the corporate governance issue in the Indian stock market.
"Over half of the float of the stock market is owned by wealthy families that own huge stakes in companies," Anand said. "And oftentimes a particular stock will move more based on the fortunes of a family than based on the fundamentals of the company."
He explained that the financial services sector has benefitted from the government's decision to only give banking licenses to professional management teams instead of big industrialist families.
"What that led to over the last 15 years is that financial services companies have actually performed in line with India's growth and they have good shareholder returns," he said. "More importantly, they have really good corporate governance, which has led them to beat the Indian benchmark by 70% a year for about 15 years."
To capture the long-term compound returns of the Indian financial sector, Anand, Singh, and Nicholas Thadaney, who had been the former CEO of the Toronto Stock Exchange, co-founded the Nifty India Financials ETF (INDF).
The fund, which tracks the Nifty Financial Services 25/50 index, has returned 29% since its inception on October 21, according to the firm. To be sure, the fund is still new and has just $2.4 million in assets compared to the iShares MSCI India ETF, which has $5 billion in assets, according to Morningstar data.
Six stock picks with huge upside potential
For investors wishing to profit from the fintech and internet revolution with the assurance of good corporate governance, Anand highlighted six Indian financial stocks that he believes have "huge upside potential."
Anand referred to the stock as the "open secret amongst the smart money in New York."
"Whether it's family offices or high-net-worth individuals, anyone that has any connection to India or has an allocation to India is mostly in the financials," he said.
He explains that most of these smart-money investors own the American depository shares of HDFC Bank (HDB), but the problem is that the stock trades at a 20% premium to its underlying value due to huge demand.
"What we brought to market is an ETF that trades pretty close to its net asset value and in fact has HDFC Bank as its largest holding," he said. "So now investors can buy a product that offers the same exposure without paying the 20% premium."
The second-largest credit card issuer is considered to be the "American Express of India."
"Credit cards are interesting because India, like many emerging markets, has historically been a cash economy," he said. "What do you do when a cash economy collides with the e-commerce revolution. How are people going to go from the local vendor with cash to transacting online, what you really need are both e-wallet and credit cards."
In Anand's view, the only way for investors to play this e-commerce boom in India is SBI card.
"As of last quarter, already over half of their payments, in terms of gross market value, were done online," he said. "I haven't come across any other credit card company in the world where half of the spending is online spending. What it tells you is that as online spending grows more and more, this company is in a prime position to benefit from it."
Separate from HDFC Bank, HDFC is India's largest mortgage lender.
"Mortgage penetration in India is very low. It's only 9% in terms of how people acquire houses," Anand said, "which is ridiculously low if you think about the young demographic where half the population is under 30, rising urbanization, growth of the middle class, and the access to formal financial tools using online price comparison websites."
On top of that, housing affordability in India is at its best level since 2004, Anand said, citing a recent report from investment bank Jefferies.
"It's been 16 years since homes were this affordable in India and usually when that happens, you get a super boom cycle," he said. "It creates a really positive feedback loop of rising home prices and higher wealth effect, which is more transactions in general."
HDFC Life, SBI Life, ICICI Prudential Life
Coming out of the COVID-19 pandemic, India's life insurance industry is at an inflection point and Anand believes that HDFC Life, SBI Life, and ICICI Prudential Life are three top life insurance stocks to benefit from the trend.
"COVID-19 has been a wake-up call for a lot of people in India. The reason this wake-up call is important is that India has historically had very low life insurance," he said. "Only one in 40 people in India who should have life insurance have life insurance and only 17% of Indian risk is insured."
The three stocks are also a play on the rise of fintech in India as they navigate the transition from agent-directed insurance buying and selling to online shopping of insurance policies.
"There are a bunch of these Indian fintech unicorns that just do price comparisons for insurance," he said. "A lot of younger people are just being a lot smarter about comparing and shopping for an insurance policy.