India Capital Growth Fund Limited

07 January 2011

India Capital Growth Fund Limited (the "Company" or "ICGF")

31 December 2010 NAV Statement

Net Asset Values

The Company announces its net asset values per share as at 31 December 2010:

Net asset value per share - undiluted: 73.92 pence

Net asset value per share - fully diluted: 73.92 pence

Portfolio Update

Fund Performance

The portfolio finished the year with an overall increase in the NAV of 24%, albeit with a slightly disappointing December. Although in sterling terms the net asset value rose 2.5% for the month, this was due entirely to the strength of the Indian rupee which rose 3.2% in December.  The fall of 0.8% local currency terms can be compared to a 0.5% rise in the BSE Midcap index for December. The explanation for this performance is a mixture of poor stock specifics in a few cases and sector allocation. Following a series of incidents that knocked the market's confidence in November, the main board stocks recovered quickly.  This was not the case for the medium and smaller companies which gave up most and have recovered (so far) by much less.

To an extent this is the nature of the beast, nevertheless there are two principal reasons. First, while the issues of November remain unresolved and are still fresh in investor's minds, the quality bias favours the larger companies with more transparency and better corporate governance, at least at the mean. Secondly, volumes in the market have also been affected by these events and this has been compounded by the traditional collapse of liquidity in the run up to the New Year. Our expectation is that this will correct itself, but how and when depends on the degree of further bad news emanating from these events and whether foreign investors continue to favour India in 2011 to the same extent as they did in 2010. 

The defensive areas of healthcare and utilities held up well this month and whilst the exposure to the former is sufficient the performance of the stocks within it was disappointing. Portfolio heavyweight Bilcare fell 1.6% on thin volumes, whilst Opto Circuits fell 4.5% in the same mould. The portfolio has no exposure to utilities and recent events are unlikely to change that view. In consumer staples it was a case of "having no sugar", an exceptionally volatile area of the midcap market which performed brilliantly this month. Once again recent events are unlikely to change that view. Stock selection was positive in the materials space where Sterlite (up 16%), Bhushan Steel (up 9%) and Rain Commodities (up 8%) all performed well;  but United Phosphorus was the let-down falling 8% as the market digested the most recent acquisition and the equity dilution from the conversion of some outstanding debentures. In the areas of financials, industrials and IT the portfolio performed adequately.

Market Outlook

As is generally the case the outlook remains a concoction of the constructive and the worrisome. The recent rise in the oil price is further pressurising the current account deficit. This is not a problem today as the deficit is adequately financed and the balance of payments remains in surplus. The financing however is dependent on a high component of portfolio inflows and these can prove temporary in times of market stress. In addition, although price inflation is expected to continue to trend down in the near term there are signs that medium term outlook maybe for upward pressure that the market has not yet factored in. This will come not only from the rise in international commodity prices, some of which will inevitably be passed onto the consumer, but also from domestic food inflation which at the wholesale level rose 14.4% for the week ended December 18th, a ten month high. In the recent monetary policy review the Reserve Bank kept the level of interest rates unchanged but the bias remains hawkish and more rate hikes are expected in the early part of 2011.

On the positive side, the latest Industrial Production report showed a rise of 10.8% year over year for October prompting some upward revisions to next year's GDP forecasts. Although clearly good news, this is also adding to the inflationary debate. But as capacity utilisation levels increase, opportunities arise in the economy and in particular the capital goods sector. Corporates are in a strong position to increase capital expenditures to match the pickup in demand and this bodes well for revenues and earnings. In addition the government has started to signal that the heavily delayed infrastructure spending plan will shortly regain momentum, boosting order books and easing liquidity in the banking system. Evidence of this has already come to light from the National Highways Authority of India (NHAI) which has signalled it is ready to step up the pace of road projects significantly.

Conclusion

As the New Year progresses it may be necessary make small adjustments to the emphasis of certain areas of the portfolio to take account of the changing economic environment. This is the norm. Underlying that however remains the long term belief that the structural drivers of the Indian economy continue apace, and that the mid and small cap areas of the market capture the most interesting and cheapest ways to play these exciting themes.  We are looking forward to another year of positive returns from the Indian market.

Analysis of holdings at 31 December 2010

Top 10 equity holdings at 31 December 2010

Portfolio breakdown by size at 31 December 2010  

* including one arising from a demerger, pending listing.