By Gregor Stuart Hunter
Hedge funds investing in India are having their best year ever, outpacing those in other emerging markets and generating above-market returns, a feat eluding many of their global peers.
India-focused hedge funds were up 24% in the first half, according to Hedge Fund Research Inc., better than funds focused on any other single strategy or country. They also beat the 16% gain of India's benchmark S&P BSE Sensex index and 14% gain of the MSCI India index.
Globally, hedge funds are facing criticism for failing to justify the high fees they charge. They have gained an average 3.7% this year, well behind the S&P 500's total return of 9.3%, including dividends, Hedge Fund Research data show.
India-oriented hedge funds, which are mostly stock-focused, have outperformed mainly by trading in small-cap and midcap stocks, which have been on a tear this year. The benchmarks they are beating are dominated by large-cap companies like Infosys Ltd. and Tata Motors Ltd., whose performance has been relatively muted.
Some relative newcomers are gaining prominence. Take London-based Habrok India Fund, spun out of Habrok Capital Management's global hedge fund just over 18 months ago. It returned 24.5% through May 31, fourth-best among 473 global hedge funds ranked for clients by HSBC.
Habrok, which manages $50 million in assets and generated a 15% return last year, attributes these gains to bets on stocks in the consumer-discretionary, building-materials and insurance sectors--which it expects to benefit as economic reforms increase private wealth. The fund has a mandate to use leverage to fuel its market bets, and to short-sell stocks, though like most India-focused hedge funds it has mostly pursued a "long-only" strategy.
"We think the country is going to transform over the next decade or two, " said Rahul Khanna, the fund's London-based portfolio manager.
India's stock market has been among the world's fastest-rising this year, despite a bumpy ride for some measures Prime Minister Narendra Modi has introduced in recent months--notably withdrawing most of the country's currency from circulation last November.
A series of interest-rate cuts since 2015 has helped push India's growth rate past China's. The pace could hit 7.2% this year, the International Monetary Fund forecasts.
The optimistic outlook has drawn in foreign institutional investors, who plowed a net $8.4 billion into Indian stocks in the 12 months through July, according to data from the Securities and Exchange Board of India, as domestic Indian mutual funds funneled in a net $12.1 billion.
"Liquidity is just gushing in," said Andrew Holland, chief executive of Avendus Capital Public Markets Alternate Strategies LLP, one of a handful of India's onshore-based hedge funds. "Interest rates have fallen and traditional real estate and gold as an option isn't really there, so you're getting more money in equities than before."
Mr. Holland said large-cap information-technology and pharmaceutical stocks that have outperformed over the past decade might struggle to maintain their pace and justify their valuations. Others say small and midsize companies are better placed to capture changes in the types of products that consumers demand as India becomes richer.
India's domestic hedge-fund industry owes its existence to regulations issued in 2012. Before that, several funds set up offshore in places like Singapore and Mauritius, where they enjoyed favorable tax treatment, although the loopholes have recently been closed.
The universe of India-oriented hedge funds remains relatively small. Those with a mandate to invest in India alone total just 42 and manage $4.58 billion in assets, according to data from EurekaHedge. Contrast that with 156 funds and $26.94 billion for funds that invest in Greater China, which includes Hong Kong and Taiwan.
Some say Indian hedge funds' performance is still unconvincing. Their returns seem less exceptional set against those of the small-cap stocks they invest in, said Peter Laurelli, global head of research at eVestment, which collects data on the asset management industry. The MSCI India Small Cap Index gained 29% in the first half, slightly more than India-focused hedge funds.
Hedge funds invested in India don't consistently outperform wider benchmarks. HFR's index of India-focused hedge funds fell 0.1% last year, when the Sensex gained 2%, and gained 4.4% in 2015, short of the Sensex's 5%.
Write to Gregor Stuart Hunter at [email protected]