A top-outperforming Morgan Stanley fund is betting some private-sector lenders in India will emerge from the coronavirus pandemic stronger than others.

Kristian Heugh, lead manager of the $4.3 billion Asia Opportunity fund, expects private banks with “strong deposit franchise" and “quality underwriting standards" will gain market share from both state-owned lenders and the weaker private ones.



“The events of this year are likely to accelerate both these factors – strong banks will gain share at a faster pace and the pace of digital adoption has picked up sharply," Heugh said in an interview. His Asia excluding Japan-focused equity fund is up 29% this year through Sept. 22, beating 98% of its peers as it invests in cash-rich companies that it finds undervalued.

Financials have been the worst-performing sector in Indian stock market this year, slumping more than 30%. Soured loans are expected to swell to the highest level in more than two decades in 2021 following the world’s strictest lockdown measures. One silver lining is shutdowns are forcing Indians to access banking online, a habit that could see banks cut physical branches and save costs.

That’s why Heugh is looking past the short-term uncertainty to bet on private lenders like HDFC Bank Ltd., the best-performing financial stock in the S&P BSE Bankex index this year even after a more than 19% fall.

The bank was among the fund’s top ten holdings as of end-August, accounting for 5.3% of its portfolio. The lender currently faces regulatory scrutiny in the U.S. And its chief executive officer is set to step down after 26 years.

The bank’s lower cost base, coupled with “industry-leading digital capabilities," can enable it to continue taking loan and deposit market share from weak public sector banks, Heugh said, adding that HDFC has “strong" risk management processes.                                             

The fund has also invested in ICICI Bank Ltd. and Kotak Mahindra Bank Ltd. It initiated a position in the former -- also among its top holdings -- in April after shares fell more than 30% in March. They have gained 9.5% since the start of April.

The fund’s biggest exposure is in China, with consumer discretionary its top sector. Chinese companies such as tutorial provider TAL Education Group and soy-sauce maker Foshan Haitian Flavouring & Food Co. -- that have climbed 53% and 75% this year, respectively -- were among the top contributors to performance.