Franklin Templeton Investments may increase exposure to bonds in its Indian fund if the highest stock valuations in 15 months aren’t backed by growth in company profits.
“The biggest risk to Indian equities is if earnings growth remains below par,” Anand Radhakrishnan, chief investment officer at Franklin Templeton India, said in an interview. “We have shifted money from equity to bonds in the past six months in our dynamically-managed fund. We can go all the way to 90:10” in favour of bonds if earnings growth doesn’t pick up, he said.
Indian stocks and bonds have rallied as Asia’s third-largest economy benefits from the gush of money flowing into emerging markets amid a renewed wave of global policy easing. Valuations for India’s key equity gauge are now at levels that have presaged losses in the past, while the appeal of local debt has been burnished by the prospect of interest-rate cuts.
“We have to see how earnings and valuations evolve,” said Radhakrishnan. “Earnings depend on economic growth, which is showing a mixed trend. We need a synchronised upswing.”
India is expanding at the fastest pace among the world’s major economies, though the benefits of the growth have yet to filter through to corporate profitability given a tepid investment climate, rising bad loans and weak global demand. June-quarter results of eight of the 16 companies on the S&P BSE Sensex that have reported, have disappointed investors. That’s stoked concern the gauge’s 21% jump from a February low is overdone.
“We don’t see a meaningful growth recovery anytime soon and the earnings estimates are ahead of reality,” Gautam Chhaochharia, head of research at UBS Securities India in Mumbai, said in an interview with Bloomberg TV India last week. “The risk reward is unattractive” at current market levels, he said.
The Sensex’s rebound from February sent its price-to-book ratio to the highest in more than a year. The last time the metric was this high, in June 2015, the index slid about 5% over the following two months.
The 30-stock measure traded at 16.5 times 12-month estimated earnings last week, the highest since April 2015. Foreign inflows into shares totalled $1.7bn in July, a fifth month of purchases, marking the longest run since 2014.
Sovereign bonds have rallied as a pickup in monsoon rains eased inflation concern and as speculation mounted that India’s new central bank governor will be more aggressive in cutting interest rates.
The yield on benchmark 10-year notes slumped 28 basis points last month, the most since May 2013, with its close last week being the lowest in 38 months.
At 7.21% on Wednesday, the yield is still the highest among major Asian markets, with investors including BlackRock, the world’s largest money manager, and HSBC Global Asset Management, saying they are bullish on the debt. Foreign holdings of rupee-denominated government and corporate notes rose by about Rs70bn ($1bn) last month, the most since October.
The Franklin India Dynamic PE Ratio Fund, which split its Rs7.6bn assets equally between a stocks and an income plan on June 30, has returned 11% annually in the past five years. That beat peers in the fund of funds category by 78%, according to data compiled by Bloomberg. The Franklin India Balanced Fund, which held 65% of its Rs11.6bn assets in stocks, has risen 15% annually in the past five years, surpassing 97% of peers, the data show.
“India as a high-yielding market has attracted larger investments in the last one year,” said Radhakrishnan. “Equities too have gone through a re-rating as investors chase stable companies with some growth.”