"There's actually no shortage of money which could flow into India," says Mark Mobius, Executive Chairman at Templeton Emerging Markets Group. In this interview with Aarati Krishnan, he also shares his outlook for emerging markets, especially India and China, and talks about tech stocks.
You've been travelling around India. What's your sense of the country? You recently wrote a blog about your visit to a Chinese mall.
Yes, I visited the Chengdu mall in China, the largest mall in the world, and was really impressed by the spending potential in the country. It also brought home to me that being on the ground, studying what people are doing and how they're living give you a better sense of growth and activity in a country than simply reading the numbers. I have found that this is true for India too. You visit many cities, companies; you stay at hotels and you get a sense of how a lot of investments have been made in India, which are really going to pay off in the long run. I am so impressed by this hotel I'm staying in here that I immediately sent an email to my office in Singapore saying that we ought to have our next analysts conference here. There's a lot of value here in India that is not fully recognised.
Why are investors so sceptical of emerging markets as an asset class, even though they've been able to deliver higher economic growth for many years? Why is there so much disconnect between the fundamentals and the capital flows in these markets?
I think that's because of volatility. Emerging markets tend to be somewhat more volatile than those of developed countries. The largest mass of money going into emerging markets comes from the developed world. Therefore, whenever there's a problem in these markets, and particularly if their home country is doing well, foreign investors will retreat and take money out very quickly. That creates volatility. And when the herd starts moving, the whole herd moves out. That happens in the opposite direction as well. We have to accept this. But emerging markets have begun to offer value after the recent falls and investors are beginning to recognise that.
However, stock markets are so volatile that they're not a good reflection of what's happening on the ground. If you look at the economic growth of emerging markets, even with the problems in Russia and the problems in Brazil, they are now growing at an average of 5 per cent. If you know that, you know that emerging markets are actually doing very well.
But the good news is that internal markets in these countries are becoming bigger and local investors are becoming more influential. That can help reduce volatility.
What's your view on China after the recent correction? The government intervened to stop the fall and that seems to have shaken investor confidence too.
I think this is temporary. China is really keen to move to a market-driven economy and model itself on the US because it has realised that a market economy leads to more efficient allocation of resources. This is something the Communist Party has not been able to do. But they are in a dilemma right now. They want a market economy but they don't seem to like the volatility that comes with it.
You didn't have to be too smart to figure out that Chinese stock markets would fall. Once they fell, the extent of the fall surprised everyone. There's a rule in China that allows a company to suspend trading if it feels the stock is too volatile. So, when a few used this rule, everyone jumped on the bandwagon to suspend trading. But that phase didn't last very long. Many of the stocks are now back for trading. There's also another problem that we have, which is called the short-term flip rule. If you own more than 5 per cent of a company and if you sell and make short-term profits, those must be handed back to the company. These kinds of restrictions are clearly not good for the market.
But in any case, most of the Chinese stocks that Templeton buys are not bought in China but in Hong Kong. The Hong Kong market did not fall as much as that of Shanghai. There's a big discount that exists between the same stock traded in Shanghai and in Hong Kong. The foreign-exchange controls in China prevent that gap from being bridged too quickly.
The worry about the Chinese real-estate bubble is also overdone. In big Chinese cities, there's plenty of demand for housing and the market is quite vibrant. Statistics show that residential apartment sales are rising. China, you should realise, is nowhere near the US on urbanisation. There's a lot of migration happening to cities and that's driving real housing demand. A move towards services in the economy will also aid that shift. With manufacturing, China is trying to move to a model where they do manufacturing with more value added within the country. You now have companies, like Huawei, producing sophisticated telecom equipment in China. Low-cost manufacturing is moving to destinations like Vietnam and Bangladesh. While this shift happens, the growth is likely to slow down. Basically, the transformation both in China and India is likely to be the same as that in the US earlier.
I know many people have bemoaned the fact that China is slowing down, but I don't understand that. It's the second largest economy in the world and it's growing at 6-7 per cent!
Will this lead to lower imports of commodities by China? No matter what goes wrong with commodities, today people like to attribute it to China.
Yes, China is a major user of commodities, and if Chinese growth slows its commodity imports have to flatten out as well. But where people are making a mistake is in understanding the pace of that slowdown. China is still importing more commodities than before. Its import growth has decelerated; imports aren't shrinking. Going forward, I do think there will be good demand for commodities as China becomes a value-added manufacturing economy. I am positive on commodities as both China and India focus on manufacturing. This transformation is not going to happen overnight.
Today the best way to gauge where China is going is to read the ten-point programme promulgated by the Communist Party last year. They first say, "We will move towards market pricing." This means that the government will no longer try to subsidise commodities or control their prices. They will depend on global markets to decide the price. That's a giant change.
Two, they have said that local governments will be allowed to raise money from bonds. This means that bond markets may get developed and that local governments will no longer depend on the Centre for funds. That's a big change too. Another point in this programme is that local governments will be allowed to raise property taxes. What this will mean is that local governments will probably not be acquiring property without paying proper prices. This has been a contentious issue in China, with a lot of protests against compulsory land acquisitions and so on.
The recent yuan depreciation also signals a move to a market economy. The government wanted to move in this direction and opened the door a little bit and then there was this volatility and everyone got so worried. But if they want to be a reserve currency, they will have to decide how they will allow local money to leave or global money to flow in. Now there are restrictions on both sides.
What's your view on capital flows into India? Is India making enough progress on reforms?
Yes, unlike previous governments, this government has clearly stated that they want to drive growth and reforms. One of the most significant reforms in India I believe will be the unified value-added tax (GST). There's actually no shortage of money which could flow into India if there were fewer restrictions on sectors/stocks and so on. The confusion on taxes is also an issue. When foreigners come in with long-term investments, they want to know that the government won't change its mind on taxes. That's why it is ironic that Indian companies get listed overseas. They should be listing here.
As more reforms come in, you will see more money coming and the strengthening of the currency. But it depends on the speed with which reforms happen.
On tech stocks, would you say we are seeing a repeat of the dot-com bubble of 2000? Templeton believes in the principles of value investing, but value investing strategies have really underperformed across the world in the last five years...
Yes, internet stocks today make up a good proportion of the market capitalisation today. They generally trade at much higher valuations than normal stocks and that has pushed up the overall market valuations. And because of the out-performance of internet stocks, traditional value portfolios have not done so well.
On internet stocks, this is a little different from what we saw in 2000. In 2000, you really had lots of companies in the tech space which were not making any money at all from their businesses. This time around, many of these internet businesses, at least those that are listed, generally are making money, i.e., they are cash-flow positive. But not all the firms are making money. There will be a lot of IPOs that will never make money and a lot of burnt fingers resulting from that. So, today I don't think we are in a similar situation. But we don't know how much farther this can go from here.
What parameters do you look at while selecting a stock?
Return on capital employed, in our view, is the most important parameter. You give a company a lot of equity and debt and you want to make sure they are earning a decent return on it. We would also like to see the company returning cash to shareholders by way of dividends. The quality of management is also important to us. Yes, this is something that can't be measured, but it is very important. This is a strength that India has. It has some terrific managers. If we are able to free up regulations, you could have world-class companies.
This interview appeared in the December 2015 Issue of Mutual Fund Insight.