Indian equities are not too hot to hold- Templeton AM

Indian equities are not too hot to hold- Templeton AM

A fall in domestic inflation and an improved current account deficit, along with a new reform-minded government, have been the key factors driving the market.

“In spite of the rally, the market is not trading at valuations higher than its long-term average. Excess optimism has not been factored into current prices,” Rajah said in an interview with Fund Selector Asia.

A look at the PE of Bombay Stock Exchange's Sensex:


He sees the Indian economy growing by 7-8% over the next two-to-three years, faster than China’s projected GDP growth.

“The potential is much better than in the past. We are going to have a cyclical recovery,” said Rajah, who manages the Franklin India Fund with $4.1bn in AUM.

“The most notable pressure points in the past have been the high current account deficit, high inflation, low export growth due to weak conditions in the US and Europe, and the policy paralysis of the previous governments. Now all these pressure points are relieved.”

Companies’ margins to improve?

Rajah said Indian company margins tended to shrink from 2010 to 2014. The average earnings growth of companies has been in the single digits over the last few years, lower than the long-term average of 15%. 

However, the deflationary trend in commodity prices has taken some pressure off operating costs.

“Capacity utilisation has gradually started improving. Companies will now have a better pricing power.

“Margins will gradually recover over the next three years. When margins start recovering, the average earnings growth can be above 15%.”

Financial sector evolution

Rajah looks for companies with a combination of growth, quality and sustainability. 

The fund held 58 companies in the portfolio as of 31 March.

He is overweight the financial sector, which accounts for nearly 28.3% of the fund’s assets. In comparison, the sector has an 18.1% weighting in the MSCI India Index, the fund’s benchmark.

He believes the financial sector is undergoing a fundamental change due to the government’s anti-corruption drive and its initiative to provide bank accounts to the poor population. 

The policy actions are likely to support financial sector grow.

“More than half the savings of people are held in non-financial assets.  But gradually a higher proportion of savings is going to come into the financial sector.”

He prefers private sector banks over public sector entities. He holds HDFC Bank, ICICI Bank and Yes Bank in the portfolio.

“Private sector banks are better managed, have higher capital adequacy ratio, good balance sheets and better customer service. They are gaining market share. Their market share has increased to nearly one-third currently compared with less than 10% about ten years ago.”

Their market share is expected to rise further to nearly two-thirds of the banking system in the next ten years, he said. 

Riding on rising demand

The fund is also overweight the consumer discretionary, healthcare and industrial sectors.

The consumer discretionary sector has about 11.7% weighting in the fund compared to an 8.8% representation in the index.

As an example of an investment in this sector, he cited Tata Motors, which is benefitting from growth in luxury automobiles. Tata sells the Jaguar Land Rover brand in India, and sales of this high-end vehicle are outpacing the luxury car segment as a whole, he added.

The healthcare sector accounts for nearly 12.2% of the fund’s assets, whereas the sector has a 10.4% weighting in the benchmark index.

Sun Pharmaceuticals (4.6% weighting), in which he started investing 15 years ago, is the largest holding.

Rajah, however, has avoided the real estate sector, which tends to have poor corporate governance, he said.

“The sector is notorious for political connections and probably [companies need to be] on the right side of the politicians to acquire land and building permits.

“Things can change in the future. The current government seems to be working toward eliminating corruption in many sectors. At some point, even the real estate sector might be reasonably free of corruption.”

He also avoids exposure to cyclical, low-margin and highly- commoditised sectors.

Accordingly, the fund is underweight the energy sector (4% weighting) compared to 10% weighting that the sector enjoys in the index.

A look at the run-up in key Indian indices in 2014: