Equity markets may stay difficult around the world: Manraj Sekhon

The investment environment today is probably a very sharp illustration of what we should continue to expect for the next 5-10 years because the world is a complex place. The geopolitics where different powers around the world are eyeing for influence. There's a rebalancing of global power that is occurring. Trust in government is a challenge globally, it's not just in the West. The trust in government is a challenge and there is populism. India is an extreme example of that, but it is happening elsewhere in the West as well. So, you put that all together, that's creating a lot of geopolitical, socio-political, socio-economic uncertainty.

After Covid, we have had the Russia-Ukraine crisis, conflict in the Taiwan Straits and now what's happening in the Middle East. So the US is very stretched dealing with all of these challenges. It has to make choices about where it allocates its resources. Coming back to what you mentioned about bond yields, bond yields have spiked. Growth has been very strong, resilient in the US in particular, surprising a lot of investors, how strong and resilient it has continued to be—jobs growth, consumer growth, corporate profitability. So it is a very complex environment with bond yields, short bond yields around 5 percent.  That's not a bad return for any investor: US, non-US, 5 percent in US dollar terms without doing very much is a very attractive return which means that it is going to continue to be a difficult market for equities generally around the world.

Q: What are investors looking for now?   

Because we are in this relatively low growth environment around the world, investors are looking for growth, visibility, certainty and really resilient growth. So when they find that growth, they will pay a premium for it. That is what we’ve seen in the US, where you have seen these very large mega cap stocks, the so-called magnificent seven, deliver a very strong return this year. Over 80 percent of S&P returns in the first nine months of this year came from those companies. So the rest of the markets actually had a very difficult time but the headline masks a lot of differences in performance.

People also want growth that is relatively less correlated, that's where India comes in. So we have seen in the last couple of years the views on emerging markets shift. China was very much in favour pre-Covid. Now a combination of Covid, domestic transition in China, geopolitical tensions between the US and China and in the other parts of the world means that China is no longer in favour. People are looking for sources of growth in the emerging world, excluding China, which is resilient but also less correlated and that's where India comes in.

As a global investment organisation, the amount of interest we have seen from foreign investors looking to allocate to India is probably the highest we have seen.

Q. In the last one year?

I would say in the last 18-24 months, and it has continued. Now, that doesn't necessarily mean the interest is turning into flows but there's a lot of curiosity and interest, there's better understanding for all the reasons I mentioned before. I think India as a destination for funds will continue to be a good place. India will continue to have its own share of setbacks, some self-inflicted, some otherwise.

The elections are coming, [they] will be a source of uncertainty, maybe volatility in the markets but so far India has been very resilient and India has demonstrated very strong growth. We like India. We think there's some very interesting bottom-up opportunities in India across a whole range of sectors, large caps, small caps, consumer financial services, technology, industrials, that breadth of opportunity is quite unusual. We like India in that respect.

Also read: Why are FIIs fleeing Indian stocks? Blame it on bonds

Q. Currently, equities are struggling with heated competition from other asset classes as people are shifting their money to fixed income while global central banks all over the world have started to increase interest rates. Are you re-looking at your portfolio and re-strategising your investments from equities to fixed income?

So within Templeton and the business which I manage, we only focus on equities.

We certainly have colleagues that look at both fixed income and equities, but we only focus on the latter. I think investors are reallocating to fixed income from equities because, as I said, 5 percent in US dollar terms is attractive.

We are probably in the later stages of the economic cycle and the tightening cycle in the US. In Europe, it looks like inflation has peaked. In the US, growth is still very resilient. Inflation looks to be quite sticky and it will probably not go back down to the extraordinarily low levels of the last couple of decades but inflation is probably close to peak. So when you put that together and you look at equities and fixed income on a three-five-year view, is this the right time to be allocating to fixed income relative to equities? I would argue not.

I would argue, depending on your time horizon, this is not a bad time to be looking at equities. If you look around the world, the US has performed very well in terms of the equity market returns but that performance has been concentrated in a very small number of stocks. So the rest of the market has actually not done terribly well.

If you look at the rest of the world, it's also lagged. India is a standout, but Europe has lagged. Japan has lagged. China has certainly lagged. Emerging markets, outside of India, one or two other exceptions have lagged. So there's a lot of opportunities outside of the US where I think you can find valuation and growth.

Q. There has been a lot of noise and interest for ESG funds. India has been lagging in green and impact investments but after Covid, lot of new fund launches were ESG-focussed. But that enthusiasm is cooling off gradually.  Do you think that entire clamour for ESG investments is dying now? How do you look at ESG now?   

There are many different ways of looking at ESG investments. Some investors look at companies that have strong ESG credentials and invest on that basis. We try and think about that whole area in terms of sustainability. Now what does sustainability mean? Sustainability is about sustainability of the business model that means companies that can operate with all its stakeholders whether it’s clients, customers, community, employees, in a sustainable way, environmentally, as well as, how it ensures that all stakeholders benefit in as much a fair way as possible. Now companies that may not have great ESG credentials today but are transitioning in a sustainable way provide very attractive returns.

It is very important to think about these companies and these areas we invest in in a holistic way. What does sustainability really mean? So companies in India, for example, that for the sake of argument in the energy space that are generating significant carbon emissions but employing thousands of people that are sustaining their lives based on their employment. Are those investable? Are those non-investable? Are they transitioning? There are some investors who believe simply because they are carbon-emitting, they should be avoided.

We believe our job is to engage with these companies, work with them to see how we can help them transition to a model that's more sustainable. But their role as a sustainable business is not simply about environmental sustainability. It has to be thought about holistically. So I think we have to be very careful in how we categorise the kinds of ways we invest whether we call it ESG or sustainable. The companies we invest in, we have to think about it holistically. We have to think about it globally. We have to think about it in how it impacts the overall community not just in terms of the outcomes today.

I am not surprised some of those investments have gone badly. I think when investors focus on a fad without thinking about the long-term outcomes, that is the issue.

Also read: Morgan Stanley upgrades India equities, Fitch cuts US ratings: Tightrope walk for investors

Q. Companies may still be focusing on green and ESG investments but the mutual fund industry, somehow, is lacking that enthusiasm for launching new funds because they are probably not convinced anymore?

I would say the fact that they are setting up a new category raises questions. All investing has to be done sustainably. When I say sustainably I don't mean purely environmental. A company can’t be viable in the long term if it is not managed in a sustainable way. So whether you are investing in a mutual fund that was set up 20 years ago or a mutual fund that is set up tomorrow it has to be done that way.

Setting up a separate category, whatever it might be called, ESG or otherwise, with a very clear focus on a certain subset is going to produce a very different outcome.

Q. So it will take some time in India?

It will take time in India but again it depends on the kind of investments you make. A lot of green projects have been predicated on a low interest rate environment, that's not the case anymore. There's been a lot of capital thrown at new projects and some of these projects may not be viable in a high interest rate environment but there's a lot more capital thrown at it. There will be a market clearing and that will provide opportunities.

(The reporter was in Hong Kong at Franklin Templeton’s invitation)