Geopolitical risks don't seem strong enough to challenge RBI's rate cut logic: Janakiraman of Franklin Templeton

Also, the recent geopolitical risks do not seem strong enough to derail the Reserve Bank of India's (RBI) rate cut logic, he told Mint in an interview.

Nonetheless, he pointed out that if the tensions escalated significantly, then India’s risk premium could rise.

Besides, he believes a key risk to equity returns in 2025 is the heavy supply from initial public offerings (IPOs), qualified institutional placements (QIPs), and promoter sell-downs, a trend that surfaced in late 2024 and contributed to the market’s decline.

“Supply is increasing again, and if there is one major risk to returns this year, it is likely the excess supply of shares," he said.

Edited excerpts:

Are the recent tensions between Iran and Israel making clients anxious about investing in equities?

It is still early, so I haven’t surveyed clients informally yet on their reaction to geopolitical tensions. I suspect they view it through market performance—if markets stay stable, concerns remain low. So far, markets have been fairly resilient, keeping nervousness among Indian investors limited.

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However, if news like rising crude prices hits, nervousness could increase. How investors react in such scenarios remains to be seen, but for now, they don’t seem overly spooked by the geopolitical situation.

How seriously could this West Asia conflict impact the Indian markets, especially in view of the US involvement?

There are two ways to look at the ongoing West Asia tensions. In the short term, geopolitical risks have risen, but market reactions—especially in oil—suggest concerns are limited. Oil futures for the next 6-12 months have returned to pre-conflict levels, suggesting that the spike is expected to be temporary.

The key variable is how Iran responds. However, Iran’s capacity to escalate meaningfully has been weakened in recent weeks. It is a bit unlikely that, even in the short term, things will escalate to the point where the Strait of Hormuz is blocked for long. Oil prices can spike above $90-100, but the chances of a prolonged disruption look low. Even if it happens, the risk should be short-lived and unlikely to affect India much.

A global brokerage report said the escalation of the geopolitical conflict in the Middle East could drive oil prices up to $120/130 per barrel. What is your sense?

Keep in mind, the oil market is currently well supplied. Before this event, it was actually oversupplied, reflected in weak prices, and the Organization of the Petroleum Exporting Countries (Opec) was even considering a production increase to regain market share. So, the supply-demand dynamics don’t support high prices.

The key question is whether geopolitical tensions can override these fundamentals in the short term. That could add a risk premium of $40-50, though it is hard to quantify. Even if that happens, it is unlikely to last long.

How do you view the rate cut cycle in light of the ongoing geopolitical tensions, especially after the RBI has already implemented a 50-basis-point cut?

If you look back at the RBI’s rate cut, it was largely based on inflation being under control, giving them the room for an aggressive cut and liquidity support. The key question now is whether ongoing geopolitical tensions could challenge that rationale, mainly through their impact on inflation, particularly energy prices.

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From our perspective, crude, petrochemicals, and LPG are the main areas to watch. But not all are directly linked to global crude prices. For instance, retail petrol and diesel prices may stay unchanged even if crude rises to $90. So any inflation impact will likely come from market-linked commodities/fuels like petrochemicals or aviation turbine fuel. And these are not significant enough to push CPI sharply higher. For now, geopolitical risks do not seem strong enough to derail the RBI’s rate cut logic.

Do you think that this conflict would increase India's risk premium as compared to other markets?

Maybe not. There are a few things to consider. About a decade ago, a crude price spike led to high inflation, currency pressure, and macro instability. But today, the situation is quite different. Crude's role in the balance of payments is smaller, inflation is under control (under 4% vs 8-9% earlier), and key macro indicators, such as fiscal deficit, current account, and foreign exchange reserves, are much stronger.

In a high geopolitical stress scenario, global trade could slow. Countries heavily dependent on exports would be more affected. India, while impacted, is relatively more insulated due to its lower trade dependence and strong domestic demand. So, given our stable macro fundamentals and economic structure, India’s risk premium is likely to stay lower than that of many other emerging markets.

Will the risk premium edge higher, though, if the conflict intensifies?

If geopolitical tensions escalate significantly, then yes, India’s risk premium could rise.

How do you view current Indian equity valuations?

I would say Indian equities are fully valued. The Nifty is trading at about 21x one-year forward earnings. What has changed in the last six months is the drop in interest rates; yields are now 50bps lower than in January, even though valuations are at similar levels. So, on a composite basis, including both valuations and rates, today’s valuations are actually a bit more reasonable than in January 2025. This is reflected in the yield spread—earnings yield minus bond yield—which has become more acceptable. So, the market isn’t cheap, but I wouldn’t call it overly expensive either. We are in a fully valued zone, and future equity returns will likely come largely from earnings growth.

That brings up the question: Many promoters are selling stakes, and mutual funds are buying, even with valuations on the higher side. Is it the cash pile they are sitting on that gives them the confidence to deploy capital now?

At Franklin Templeton, we base investment decisions on individual opportunities. Whether it is a promoter sell-down, private equity exit, or secondary market deal, we only invest if we see attractive returns over a three-year horizon.

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One key risk for equity returns this year is the large supply coming through IPOs, QIPs, and promoter sell-downs. This risk emerged in late 2024, when heavy equity supply contributed to the market decline. Supply is increasing again, and if there is one major risk to returns this year, it is likely the excess supply of shares.

What is your process for identifying compounding stories? Could you share the key selection criteria that Franklin Templeton uses?

We start by looking at the size of the opportunity, commonly called the TAM (total addressable market). Durability matters too—you want businesses that stay relevant over time. We also consider the profit pool, since large markets with low entry barriers can lead to intense competition and shrinking profits.

That said, we stay flexible. Long-term forecasts carry prediction risks, so we do scenario analysis to mitigate this to an extent; we also update our thesis quarterly as new information comes in, especially for early-stage businesses like food delivery. Established companies offer more stability and are easier to model.

Leadership quality is another key factor. Even within the same industry, execution can vary significantly. We prefer companies with strong execution track records. Most Indian compounders succeed due to superior execution rather than any intellectual property advantage.

How do you approach risk management amid market volatility or uncertainties like tariff disputes or geopolitical conflicts?

Franklin Templeton’s primary risk management approach is investing in high-quality businesses with sustainable strengths. This applies across large-, mid-, and small-cap stocks, and the yardsticks remain consistent. This focus gives us confidence during market downturns and allows us to be more active then, as good-quality companies become available at fair valuations.

From a traditional risk perspective, we also monitor liquidity risk, especially in small-cap portfolios.

Do you focus on themes first or mainly on bottom-up stock picking?

We primarily pick stocks bottom-up, but it is not possible to ignore broader themes.

A few themes have driven markets post-covid—like defense, capital markets, and more recently, CDMOs. So yes, while we are bottom-up stock pickers, we stay aware of emerging themes.

The challenge is that these themes often come with expensive valuations. If we are convinced about a theme, we usually start with a small position and wait for a correction. We are typically more effective in the second wave; by then, we have had time to build knowledge and are better prepared.

So, while bottom-up remains our core, we stay flexible and incorporate themes carefully, even if it takes time.

Are there any sectors you believe could potentially outperform others in the next couple of years?

I think cyclical themes could see good traction, especially the investment cycle, including real estate and private sector capital expenditure. Real estate is about 3-4 years into its cycle and still looks strong. Corporate capex is also reasonably healthy, though market expectations may have been too high.

Another interesting space is consumer discretionary. Post-covid demand surge had faded, but with recent fiscal and monetary stimulus like tax cuts, lower rates, and better credit access, discretionary demand could pick up again. This may benefit sectors like autos, hospitality, and even real estate.

Do earnings upgrades or downgrades prompt you to revisit your portfolio or even consider rebalancing?

We closely track earnings revisions. It has been a strong alpha driver in India over time. We monitor three-month and 12-month EPS revisions—positive or negative—both for idea generation and refining how we manage existing holdings. So yes, earnings revisions are a meaningful input in our decision-making process.

Especially since you said future equity returns may hinge on earnings growth.

True. So, earnings revisions become even more important now.

What is your 6-12 month outlook on Indian equities?

On one hand, geopolitical tensions in the Middle East seem short-term, while tariff-related issues are likely more lasting. However, India is relatively well-positioned due to its domestic focus and potential benefits from supply chain diversification as businesses move from countries like China and Vietnam.

Post-covid demand slowed around early 2024, but with recent fiscal and monetary stimulus, I expect recovery to pick up from the 2025 festival season. Macro conditions are stable and attractive, though valuations are fairly full and equity supply remains high.

Considering these factors, I realistically expect equity returns to align with earnings growth—around 9-11% this year. Earnings growth should improve next year, possibly reaching 14%, leading to an estimated two-year return of about 12%.

How do you balance chasing growth and buying at fair valuations?

There is some judgment involved, but generally, we are value investors. Not in the traditional sense of just low price-to-book or P/E multiples, but by assessing the intrinsic value of a business and comparing it to its price. We buy when the stock price is below the value.

In high-growth sectors, prices can exceed intrinsic value temporarily, and we stay disciplined by avoiding momentum or FOMO-driven investing.

This cautious approach can be challenging in strong bull markets where prices run ahead of value. Our prudent style tends to perform better in choppier or weaker markets by its disciplined approach.