Institutional investors recalculate India exposure in emerging markets amid the AI buildout and Iran-US energy risk
Each month at BPM, we offer a slate of articles and content pieces that go deep on a particular topic. This month, we're focusing on Emerging Markets and the sectors and countries within the asset class.
India was once the darling of emerging markets for the better part of a decade. But because AI investments have dominated markets for most of the past two years, that streak has largely hit a wall.
That’s not all as several investment experts note that a cyclical earnings slowdown, stretched valuations and an energy shock from the Iran-US war have knocked the market off its perch, leaving institutional investors to recalculate how much they want in the country and where.
"Over a five-year period, India is still outperforming the overall emerging market index. Over a three-year period, not so much and a one-year period, not so much. Which tells you that something happened in the latter part of a five-year period," said Matthew Strauss, senior vice-president and portfolio manager at CI Global Asset Management.
"Last year was a disappointing year in India, especially for foreign investors because we went into a cyclical slowdown in earnings in India," said Claus Born, senior vice president and portfolio manager for Franklin Templeton Emerging Markets Equity.
"This hit the market which was also trading at relatively high valuations and came down. There are structural drivers behind it. We have higher average profitability in Indian stocks and more robust earnings growth over the last decades, which supports obviously the higher valuations," he said, adding restrictions on Indian nationals investing abroad have also kept domestic demand and prices elevated.
Where India’s investment case lies for emerging markets
Meanwhile, Christine Tan, portfolio manager at Sun Life Global Investments sees India's investment case as fundamentally unchanged over the past two decades, notably as a massive, young population drove one of the strongest structural growth stories in EM, with the World Bank projecting 6.6 to 6.8 per cent growth even amid energy headwinds.
As Michael Mortimore, client relationship manager at NS Partners explains, the math behind that shift is largely due to small increments in per capita income. Once they cross certain thresholds, it can cause demand for autos, mortgages, insurance and financial products to surge. For him, that thesis hasn't changed even as market momentum has rotated toward AI and semiconductor plays elsewhere in EM.
According to Tan, the country's status among allocators has shifted. Where institutions once treated India as simply another fast-growing EM name accessible through broad benchmarks, many now view it as warranting dedicated, strategic positioning.
"It's matured in some ways in that it's no longer just a fast-growing young emerging market country. It's now being viewed more as a strategic allocation by institutions. For the size of its country and economy, it’s a relatively low allocation within the EM equity benchmarks. A lot of institutional investors I believe, including us, are now thinking about it more strategically from a longer-term perspective," said Tan.
Still, AI has made the picture more complicated as Taiwan and South Korea have surged on the back of chip demand, and India has no equivalent play. What makes matters worse, however, is the country's IT services sector which is now under pressure from fears that AI could displace outsourcing work over time.
"It hasn't come through in the short term so there's obviously continued demand for IT outsourcing and it's probably too early to say if there will be real losers if companies will be wiped out by AI, but there will be pressure on earnings,” said Born.
Mortimore takes a longer view as he believes India's engineering talent base could position it as an AI winner once the value chain matures.
"As that value moves, the value in the AI stack moves up to the application layer, which is where I think India's advantage would be. Given their expertise in IT services, perhaps that translates across to app development in India and deploying AI," he said. “We definitely want to get less defensive now. India is still one of the biggest investment stories I think of our lifetimes."
India’s valuation premium remains a sticking point for many investors. Tan acknowledged it is partly justified as India's publicly listed universe skews toward asset-light, high-ROE financials, consumer names and tech firms like Infosys and TCS rather than commodity producers, which naturally command higher multiples.
How emerging market funds are positioning their India bets
To that end, Tan breaks the Indian opportunity into distinct parts of the capital stack. On the public equity side, SLGI gravitates toward companies tied to domestic consumption and infrastructure spending - two themes she sees as reinforced by the government's National Infrastructure Plan, originally a five-year initiative announced in 2020 that has since evolved into an ongoing policy framework after COVID disrupted the initial timeline.
The spending priorities have shifted over successive government terms, from trade-oriented projects like railways and ports under earlier administrations, to electrification under Modi's first term, to a current push into power transmission, renewables and digital infrastructure.
The private side is where the pipeline gets significant. Tan pointed to close to a trillion US dollars in identified projects and said the government has been courting foreign capital to help fund them. For pension funds with long-dated liabilities and predictable cash flow needs, Tan argues the asset class is a natural fit and Indian infrastructure can deliver higher yields than developed-market equivalents.
“CPP is actually in India. They're invested in some infrastructure assets there. They're partnered with Larson and Tubro, which is kind of the SNC equivalent in India,” Tan noted.
Meanwhile, Born sees the current infrastructure build-out as a long-overdue correction. Going back 25 years, he noted the dominant conversation around India was how poor the infrastructure was, particularly around inadequate roads, an aging railway system and limited modern transit. However, he suggests that picture is changing and the broader economy stands to benefit.
He also draws a structural distinction from China, noting India's listed companies are overwhelmingly oriented toward the domestic market rather than exports, which shapes how the infrastructure spend flows through to corporate earnings.
“From a return perspective, it’s an interesting market and if you look at the level of GDP per capita, it's still a very nascent growth story. They’re approaching US$3,000 of GDP per capita. There is a good perspective of high GDP growth over the next 10, 20 years without getting to a limit. And India is growing on average between 6 and 8 per cent so if you're getting in a cyclical slowdown, you are still at 6 per cent GDP growth and more. Most other countries would dream of this. It's a really solid market,” said Born.
Mortimore agrees, noting he believes India is destined to come out on top.
“If I had to place my bets, India is going to be one of the biggest winners,” he said. “It's still one of the most exciting markets and I think we shouldn't wait around too long looking for those valuations to keep coming back. India's just got so much going for it.”
Iran-US conflict remains a key risk for India
Still, the Iran-US conflict remains the most immediate risk, notably as India imports the bulk of its energy from the Middle East, and disruptions to flows through the Strait of Hormuz have already caused cooking gas shortages.
Yet, Strauss believes an end to hostilities could be transformative for the region. From an investor standpoint, the difficulty is timing. He questions whether the payoff comes in the second, third or fourth quarter, and warns that trying to front-run a geopolitical resolution as an entry point into India is a fraught exercise.
"I think India would probably be one of the countries that benefits the most if we can get a true peace and a normal flow," he said. “It would be an incredible positive for India if there’s a free flow of oil out of the Middle East again.”
Born agrees a resolution would hit the stock market fast.
"We had occasions over the last few weeks where we had the optimism on a solution. There have been different agreements, and you see immediately the stock market reacts with a spike," he said.
