Market not to see sustained downtrend: Sukumar Rajah, Franklin Templeton Investments

In an interview with ET Now, Sukumar Rajah, Managing Director & CIO - Asian Equities, Franklin Templeton Investments, says net flows into emerging markets would continue to be positive in 2011 and that would be the case for India too.

Excerpts:

Indian markets have fallen by about 9% for the year 2011. Are you a bit surprised with the intensity of the decline?

Not at all. We had very strong foreign inflows last year, but the domestic buying was not there and then the supply also kept increasing. So this type of a correction is a natural process. So I am not really surprised at all.

Domestic macro headwinds aside, flows now seem to be moving to the developed world. How much more of a downside could we stare at from these levels?

It is not that lots of assets are going to move from emerging markets to developed markets. After fresh allocation to equities, developed markets might see a better share compared to what we saw in the last two years. So I expect that net flows into emerging markets would continue to be positive in 2011 and that would be the case for India too. So it is not that we are going to see money shift from some of these markets. It’s just that there has been some supply and also some of the short term money that came in very strong momentum that might go out. So that might create a correction, but I do not think that we are going to see sustained downtrend in the market.

So to your mind, what then are the fair levels for Indian markets?

The current levels are fairly attractive for long-term investors. The PE ratio for the market itself was not much higher compared to the long-term average and the price to book probably is slightly lower compared to longer-term average. There is good potential for wealth creation within well managed Indian companies and so the fundamental cues of investing in good Indian companies remain and the current levels are attractive for the long-term investors.

Post the correction, would you say banks are now looking attractive looking at the kind of valuations they are now quoting at?

Yes, definitely many of them are looking quite attractive. The valuations are reasonably good and we do not see a very sharp deterioration in their margins. So we think that some of the banks are looking very attractive.

If I look at your last declared portfolio, some of the banking names you own are Kotak Mahindra Bank and ICICI Bank along with HDFC Bank, which means that for Franklin Templeton, the bias is clearly private banking. Why is that?

We are long-term investors. We are looking at the ability of the company to create value for the investor over a long period of time. The basic governance and management of the private sector banks, not all of them but some of them, give us confidence that they will be able to create value for the investors by sustaining good return on capital which comes again from sustaining margins and lending conservatively and so on and this confidence we have.

But as far as state-owned banks are concerned, we do not have the confidence because they are government controlled, we do not know much about the board of directors, how they function, we do know how some of the chief executives are selected etc. So that does not give us as much confidence as some of the better private sector banks about the ability to create long-term value.

Infosys Technologies has been a constant part of your portfolio. Is Infosys Technologies more like a bottom up idea or Infosys Technologies is there in your portfolio because you are bullish on IT?

It is a bottom up idea by and large and that is one of the reasons that the stock has been in the portfolio even though the IT sector has had good times and bad times at times, but Infosys has been a constant part of the portfolio because we have been confident about the ability of Infosys to grow profitably.

Same is the case with Bharti as well which has been your top holding. Is it the entire telecom space that you are bullish on or is it only Bharti specific?

We think that there is going to be consolidation in the Indian telecom space. So the most competitive players would see their profitability improve and not so competitive players are bleeding and their situation might not improve and the exit route for them would be merger into a stronger company or a sell out or closure. So we are not bullish on all the players. We are clearly looking at the companies that can gain out of the consolidation, they would benefit.

Bharti clearly was your big contra bet for the year 2010 and so far it actually has worked for you. What is your big contra bet for the year 2011?

We have to look at where we find value. You had earlier questioned whether there is value in some of the financial stocks after the decline. We do find some value and there are going to be some opportunities there. So we are looking at other spaces as well where the value to price equation is going to be more favourable because of irrational market movements. So we are watching the space as lots of sectors are seeing decline and when there is a negative sentiment attached towards the sector or some portions of the market, then even the better quality stocks decline substantially. So those provide us the opportunity.

Would Reliance Industries as a stock as well fall under the same category because the street seems to have disowned the stock?

I am unable to comment on Reliance Industries because we comment mainly on our top holdings and in many of our local fronts, it is not a top holding.

For someone who has identified many structural stories which was HDFC Bank in early 2000, then it was Kotak Mahindra Bank in 2003-2004, which is the big multibagger theme you are now betting on?

It is very difficult to call a multibagger a multibagger at a very early stage. Whether it was Infosys or HDFC Bank, we are looking at sustained outperformance. So whether it was going to be a 10-bagger or a 100-bagger, it is very difficult to predict at the time you get in. So you get into a stock because you think that the stock can provide a certain degree of outperformance to the market and so anything that we are looking at, we look at in a similar light rather than get too greedy and build too much of expectations out of a stock.

What about broader markets that is you have made in the small caps where the correction has been far deeper? Is it a stock-specific approach or is it a thematic approach that you are currently adopting?

We believe that in the Indian market, stock-specific approach is the best long-term approach because within every sector and within every theme, there are well managed companies and there are badly managed companies. So the quality of the management, their governance standards, their competence and so on are more important than the underlying growth of the sector. So I would recommend a bottom up approach rather than a theme-oriented approach.

So give us a few names where you have top holdings when it comes to midcaps?

We do not discuss stocks unless you have any position on our top holdings. We do not discuss stocks.

If I look at your portfolio, it has banks, technology. You are light on autos and construction is missing. Will your portfolio orientation change going forward dramatically or you feel that the stocks and the sectors which you currently own, you are confident about the delivery?

Let me put it this way. We are not expecting a dramatic change in the outlook for most of the companies in the portfolio and many of our portfolios own only a small proportion of the companies that we research. So we are looking at our entire research universe on a daily and weekly basis and seeing where we have maximum value. So maximum value that will depend on the market movement to large extent. Some stocks which are not part of our holding becomes much more attractive compared to our holdings that will make us probably change the portfolio, but if nothing changes in terms of market movement, then the reason for churn in the portfolio would be very minimal.

What could be the turning point for Indian markets, budget, earnings or it really has to be something from the government’s table?

It is time more than anything else. There are two issues. One is everything to do with the India, which has made the market little less attractive, the governance issues and so on. The second is some of the other markets are benefiting more from the global upturn because they are more export oriented and as long as global investors are having higher expectations about acceleration in the global growth, they would tend to favour those stocks and when they think that the acceleration phase is over or fully discounted, then they would come back to stories like India.

So time is the factor there and most of the selling or the lack of buying has happened because of the second factor, not so much with regard to the deterioration in the governance. It has had some impact but the bigger impact has been the fact that the other markets have a higher leverage to global growth. Over a period of time, that situation would change.

Your view on liquidity and especially domestic liquidity?

Domestic flows into equity markets have been coming through primarily the insurance companies in the last two years, but we are seeing deterioration in their flows because of the change in regulatory structure. The mutual fund flows were affected but we are seeing an improvement there. So as far as flows into mutual funds are concerned, we will probably see an improvement but we will see probably a deterioration as far as insurance flows are concerned and net net, I do not think in the next two to three months, there is going to be dramatic change in local money coming into the equity market.