My recent trip underlined the nation's growth potential, with a vibrant economy, increasing investments and the promise of fresh overseas capital into its bond market.

The burgeoning potential of India's vibrant economy is palpable from the moment you set foot in the country, with its young workforce noticeable as soon as you land.

On my latest visit to the country in September, what became immediately apparent was infrastructure improvements to ease congestion - an encouraging sign of government progress.

Construction to develop other transport links are also in the pipeline, including Mumbai Metro Line 3 connecting Cuffe Parade to Aarey district and a bullet train from Mumbai to Ahmedabad.

The bullet train will cut travelling time between Mumbai and Ahmedabad to just two hours. It underlines India's growth potential.

At an estimated cost of $13.6 billion and completion date of 2027, the bullet train will cut travelling time between the cities to just two hours, from over six hours previously. It underlines India's growth potential.

Site of main bullet train terminal (highlighted in red) and the metro (highlighted in orange) in Mumbai.

But while congestion has improved, it's from a low base. India has ground to cover to drive efficiency and keep its GDP growth outlook on track, which most economists estimate at 6-6.5% per year.

But the government is in action mode, with INR3.7 trillion ($45 billion) in public spending for the first five months of the current financial year already INR2.52 trillion higher than the same period last year.

Feedback on the ground

My discussions with companies on the ground underlined the resilience of both the domestic jobs market and India's broader economy. Company leaders aren't anticipating any imminent reduction in interest rates, with the Reserve Bank of India (RBI) having held steady at 6.5% since February and retained a tight stance on liquidity to shift inflation of 6.8% down towards its 4% target.

With recent data showing investment up 8% year-on-year in the second quarter, we see room for a pick-up in private investment, with companies' capital spending still allocated to sectors with the highest growth potential. This places less demand on the government to drive growth, allowing it to focus on fiscal consolidation and, in turn, lowering its funding requirements from the bond market.

Mumbai is awash with infrastructure projects.

Renewable energy is one area where we see an increase in investment. Sprawling conglomerate Reliance Industries - best known for its oil refinery business - has pledged to deploy capital into new energy over the long term to develop this segment of its business.

Reliance is also investing heavily in the rollout of 5G over the next 12 months to tap into India's high adoption of smart phones. A recent survey by Ericsson estimated that 31 million users were likely to upgrade to 5G phones by the end of this year.

Separately, fellow conglomerate Tata group - one of the country's largest employers - is looking for new office space to meet growing demand for its IT consultancy services.

Indeed, the nation's services exports are holding up despite the global slowdown in demand for goods. India's services balance for the second quarter of 2023 was over $4 billion higher year-on-year and has been useful to offset weakness in goods exports.

Most businesses welcome RBI's efforts to suppress foreign exchange volatility since it allows them to plan and hedge with greater certainty, although the small pick-up from rupee deposits currently on offer at around 6.5% isn't attractive enough to encourage immediate repatriation of export earnings when US dollar equivalents are above 5%.

While exporters must convert these to local currency within 90 days, most are in no hurry until they see higher local deposit rates from here, which would slow RBI's pace of FX accumulation.

Importantly, the recent decision to include Indian government bonds (IGBs) in the JP Morgan GBI Emerging Markets Global Diversified Index from June next year is a hot topic after much speculation over recent years. Now the onus is on other index providers to do the same.

Both onshore and offshore stakeholders in India welcome this development since it promises to expand the bond market's investor base, adding a positive tilt to the demand-supply dynamics for Indian fixed income.

Initially, the index provider estimated that inclusion would result in $25 billion in inflows (10% of the $250 billion tracking the index), although we anticipate higher flows since a third of the $250 billion comes from customised indices that exclude China in the investible universe. This points to a sizeable pool of active managers more likely to have overweight positions in India.

While there are fears about the potential for large foreign outflows in a risk-off environment, ultimately expected inflows would still be less than 5% of the RBI's $600 billion war chest of FX reserves.

Adding to this favourable backdrop, a recent rule change to allow banks to hold more high-quality bonds in their hold-to-maturity portfolios should provide another source of support for government debt. Together with index inclusion, it creates a positive demand picture for Indian bonds.

Reasons to be bullish

Domestic investors are known for a bullish outlook on India. But the reasons are starting to stack up given favourable demographics, its status as a global IT services hub and the fact it is a beneficiary of the China+1 strategy where companies seeking to diversify are looking to invest in India. Central bank action means rupee volatility is also among the lowest of all Asian currencies.

Few investors that I spoke to are talking about the tail-risk scenario raised by JP Morgan chairman Jamie Dimon recently that US interest rates could hit 7%, which would likely have a major impact on emerging markets, including India.

Perhaps that's because there's an expectation that income growth in a vibrant population of 1.4 billion people could counterbalance any external global shocks. If improvements in infrastructure are anything to go by, India may finally be living up to its much-vaunted promise.

Author: Soh Wai-Kiat, Investment Manager, Fixed Income Asia

"Although we forecast that major DM central banks (aside from Japan) are finished hiking, our baseline forecast implies little incentive for them to cut interest rates in the near term," Goldman Sachs foreshadows, with Raymond James charting the cooling of core US inflation to levels still higher than seen for many years. Our favourite chart this month has Apollo showing that the market is almost always wrong about what the Fed will do next. Apollo backs up with a graphic on "weak demand". SMBC NIkko gives us a view on the relationship between inflation and valuation. Tech stocks are at record highs relative to the broader market as Bank of America charts, while Goldman shows the impact on market valuations. Equitable Investors looks at movement in the EV/EBITDA multiple on tech stocks relative to bond yields. We get another take on the surge in index concentration from Bespoke - and small v large via Bank of America. Deutsche Bank reckons AI didn't drive markets. Finally we get stuck into VC, where Crunchbase data shows significantly less unicorns being born and funding remaining subdued, with the Refinitiv Venture Capital Index remaining well of its highs despite recent gains.

Goldman Sachs' policy rate forecasts for developed markets

Source: Goldman Sachs

Core US CPI

Source: Raymond James

The market is almost always wrong about what the Fed will do

Source: Apollo

Mentions of "weak demand" during S&P 500 earnings calls

Source: Apollo

Earnings multiples mapped against inflation

Source: SMBC NIkko via Bloomberg

Tech sector at all-time high vs S&P 500

Source: Bank of America

Price-to-Earnings multiples by market - tech sector elevates US multiples

Source: Goldman Sachs

US 10 year bond yield (top) mapped against US tech sector (QQQ ETF - bottom)

Source: Koyfin, Equitable Investors

S&P 500 stocks from smallest to largest - 10 years ago v today

Source: Bespoke

US small caps histoically cheap vs large caps (Forward PE of Russell 2000 v Russell 1000)

Source: Bank of America

Difference between abnormal returns for semiconductor and software firms, 20 day moving average

Source: Deutsche Bank

Emerging unicorns by the year founded

Source: Crunchbase

Global venture funding (US dollar volume)

Source: Crunchbase

Refinitiv Venture Capital Index

Source: Financial Times

The Taskforce on Nature-related Financial Disclosures (TNFD) is an international initiative that is developing a framework for companies and financial institutions to disclose their nature-related risks and opportunities. Climate and net-zero commitments are well understood, with corporations relying on the Taskforce for Climate-related Financial Disclosures that released a set of recommendations in 2017.

The idea of TNFD is not entirely new. It has built upon the foundational success of the Task Force on Climate-Related Financial Disclosures (TCFD), which focuses on the financial implications of climate change for companies. However, as the global dialogue evolved, it became clear that climate was only a part of the broader environmental narrative. Biodiversity loss, land degradation, and ecosystem collapse pose significant risks to economies and businesses around the globe. The TNFD first came into existence in June 2021 to address this gap and ensure a holistic environmental approach in corporate disclosures.

Biodiversity is the diversity of all living organisms and is the living component of nature capital. Net zero and nature are intrinsically linked, and both need to be addressed to build a better and more sustainable future. A simple example of this is that forests, which cover about 31% of the earth, absorbed 7.6 gigatonnes of CO2 p.a. over the period of 2001-2019 according to a 2021 study in the journal Nature Climate Change. Preserving - and perhaps increasing - forests are key to preserving biodiversity, helping to lower ambient temperatures of regions and sequester CO2.

Importance of a nature-positive economy

A 'nature-positive economy' is essential for a sustainable future and is a key concept that drives the TNFD framework. A nature-positive economy is an economy that has a net positive impact on nature, an economy that restores and regenerates nature rather than depleting it. Nature provides us with essential ecosystem services, such as clean air and water, food, and climate regulation. Without a healthy natural environment, our economy and society cannot thrive.

There are several things that can be done to create a nature-positive economy. One important step is to reduce our impact on nature. This can be done by reducing our consumption of natural resources, reducing pollution, and protecting and restoring ecosystems. Investing in nature-based solutions will be an important step forward. Nature-based solutions are ways to address climate change and other environmental challenges using nature. For example, forests can be used to absorb carbon dioxide from the atmosphere, and wetlands can be used to filter water and reduce flooding.

The transition to a nature-positive economy is essential for a sustainable future. However, it is a transition that will require a concerted effort from all stakeholders, including governments, businesses, and individuals.

The sectors that have the most impact on biodiversity are the logical companies that will be the early adopters of the TNFD recommendations. These sectors include materials, energy, agriculture and food & beverage. 

A framework for nature-based solutions

The TNFD's final framework was published in mid-September 2023. It includes 14 recommended disclosures covering nature-related issues, impacts, risks and opportunities that are structured around four pillars (refer Figure 1).

Figure 1: TNFD's recommended disclosures

Source: TNFD, Sept 2023.

It is hoped that the TNFD provides a clear, structured framework that help corporates understand the implications of biodiversity and natural capital for their activities. The framework is intended to assist corporates and financial institutions manage their nature-related risks and opportunities, and to support the transition to a nature-positive economy. While it is largely based on the TCFD framework, it also considers the specific risks and opportunities associated with nature.

The TNFD framework covers four specific areas:

• Nature-related dependencies: This includes the extent to which a company or financial institution relies on nature, such as for its raw materials, water, or pollination services.
• Nature-related impacts: This includes the positive and negative impacts that a company or financial institution has on nature, such as through its operations, supply chain, or investments.
• Nature-related risks: This includes the risks that a company or financial institution faces from nature, such as from climate change, biodiversity loss, or water scarcity.
• Nature-related opportunities: This includes the opportunities that a company or financial institution can seize from nature, such as by investing in sustainable agriculture or renewable energy.

The TNFD framework is expected to be a valuable tool for companies and financial institutions to manage nature-related risks and opportunities. It will also help to promote the transition to a nature-positive economy.

Some of the benefits of the TNFD framework include:

• Helping companies and financial institutions to identify and manage their nature-related risks and opportunities.
• Improving the transparency of nature-related risks and opportunities.
• Driving investment in nature-positive activities.
• Aligning financial markets with the targets of the Paris Agreement and the UN Sustainable Development Goals.

Global progress

Although the TNFD framework has only recently been settled; governments and intergovernmental organisations have increasingly called attention to the impact on nature. Pleasingly, a rising number of businesses have made pledges relating to biodiversity.
Companies globally are only in the early stages of setting a broad set of nature-related goals whereas most have set climate-related targets (refer Fig 2). The EU set a biodiversity strategy in 2020 that aims to complete 100 target actions by 2030. Some of these targets include restoring degraded and carbon rich ecosystems, converting at least 30% of its land and ocean area into legally protected areas and encouraging at least EUR20bn p.a. in bio-diversity-related financing. Despite this, S&P claims that only 29.5% of the largest companies in the S&P Europe 350 Index have set biodiversity targets

Figure 2: Corporate targets are less common for other dimensions of nature compares to climate change

Source: McKinsey

McKinsey has calculated that ~47% of Fortune Global 500 companies have set nature-related targets against one dimension of nature - generally this is against climate (refer Figure 2). Approximately 16% have set targets against three or more dimensions of nature and no companies have targets against all six dimensions that were looked at in this analysis. The Science-Based Targets for Nature (SBTN) initiative suggests that companies are more likely to focus on the key issues that directly impact their activities which could explain why no company has set targets against all six dimensions.  Cutting the data based on a sector level reveals that the sectors that have a higher exposure to biodiversity risk are leading the charge on target setting.

Figure 3: Fortune Global 500 Companies' nature-related targets by sector

Source: McKinsey

Implementation of TNFD

Implementing TNFD is not without its challenges. In particular, there's a need for:

• Data Collection: Many companies lack the data or the means to gather it to understand their complete environmental impact;
• Standardization: With no globally recognized metrics to measure nature-related risks, creating a standardized framework will be demanding;
• Economic Pressures: Short-term profit goals can overshadow long-term sustainability targets, making it challenging for some companies to prioritize nature-related disclosures; and
• Stakeholder Alignment: All stakeholders, from suppliers and employees to regulators and consumers, need to align for effective disclosure and action.

The framework is consistent with the recommended standards of the TCFD, ISSB (International Sustainability Standards Board) and GRI (Global Reporting Initiative). The recommendations have an intention to provide a practical solution for corporates to start their journey to increase the scope and disclosures over the coming years. The expectation is that, as with climate-related reporting, TNFD disclosures will improve over time.

The LEAP approach - Locate, Evaluate, Assess and Prepare - has been developed by the TNFD to help organisations to identify, assess and manage nature-related risks and opportunities. While the approach is not a requirement, it is designed to help with identification and assessment. Figure 4 provides an overview of LEAP and its elements, which covers:

• Locate: Identify the organization's interface with nature, including its direct operations, supply chains, and value chains.
• Evaluate: Evaluate the organization's dependencies and impacts on nature.
• Assess: Assess the nature-related risks and opportunities facing the organization.
• Prepare: Prepare to respond to (and report on) nature-related risks and opportunities.

Figure 4: The TNFD approach for identification and assessment of nature-related

Source: TNFD, Sept 2023

Conclusion

While the challenges are significant, the TNFD offers a critical pathway for integrating nature into financial decision-making and improving outcomes for our environment. The success of the TCFD suggests that with global cooperation and commitment, the TNFD can become an influential tool in driving sustainable business practices. Governments, financial institutions, environmental organizations, and businesses all have important roles to play.

By implementing frameworks such as the TNFD, the global community takes a step closer to ensuring that the economic activities of today do not compromise the planet's well-being tomorrow. The shift from merely profit-driven strategies to those that also account for nature-related impacts signifies an evolution in global business practices. It is an evolution that is not just commendable but essential for the longevity and prosperity of both businesses and the planet.

Tyndall will be increasingly engaging with corporates around biodiversity and promoting the implementation of the TNFD framework, as we have been with TCFD. According to work by Jarden, only 12 (24%) of ASX50 companies have nature-related targets. It was noted that BHP, Woolworths, South 32 and Origin Energy had undertaken TNFD pilots, and only Brambles and South 32 have linked nature to remuneration. 

Clearly, there is plenty of improvement required. We expect that those companies in sectors more exposed to nature-related risks such as agriculture, food and beverage, and mining, are likely to lead the charge. 

Author: Brad Potter, Head of Australian Equities

Decarbonisation is one of the most important challenges of our time, but it is also often one of the most difficult to successfully invest in.

Renewable energy stocks have been among the most popular and talked about investments in recent years, thanks to low interest rates, government subsidies, and strong demand from consumers and investors who want to support a greener future.

However, valuations of these stocks became very expensive, reflecting their current leadership rather than their future potential.

In this article, we will explain why we have been cautious about investing in renewable energy stocks and where we see better opportunities in the energy sector.

What are the challenges?

One of the main challenges for renewable energy stocks is that they are very sensitive to changes in interest rates. Renewable energy projects have long-dated cashflows that depend on the future price of electricity and the cost of capital. When interest rates are low, these cashflows are more valuable and attractive to investors. However, when interest rates rise, as they have recently, these cashflows are discounted more heavily and lose some of their appeal. This is especially true for projects that rely on debt financing, which becomes more expensive as interest rates increase.

Another challenge for renewable energy stocks is inflation. Renewable energy projects often require large upfront investments in equipment and infrastructure, such as solar panels, wind turbines, and transmission lines. These costs are subject to inflationary pressures, which can erode the profitability of the projects over time. Recent downgrades of wind turbine manufacturers have demonstrated that costs have risen dramatically. This means that renewable energy projects need to generate higher revenues to cover their rising costs, which may not be possible in a competitive market.

A third challenge for renewable energy stocks is local regulation. Whilst there may be federal incentives, renewable energy projects often face opposition from local communities who do not want projects like a wind farm in their backyard. For example, wind farms can face resistance from residents who complain about noise, visual impact, wildlife disruption, and property value decline. Renewable energy projects may also face regulatory hurdles from environmental agencies, landowners, grid operators, and other stakeholders who have different interests and agendas. These factors can delay or derail renewable energy projects, reducing their expected returns.

However, the biggest long term challenge for renewable energy stocks in our view is that most renewable energy sources provide intermittent rather than baseload power. This means that they depend on weather conditions and cannot guarantee a constant supply of electricity. This creates a problem for grid stability and reliability, which requires a balance between supply and demand at all times.

Energy storage in batteries is often seen as a solution for this problem, but it still has a long way to go before becoming widespread and cost-effective. According to the International Energy Agency (IEA), battery storage capacity needs to increase by more than 40 times by 2040 to support the growth of renewables.

Opportunities: Where to invest?

Given these challenges, we have been looking for opportunities in both providers of existing baseload power from sources such as hydro and nuclear, as well as solutions for reducing energy demand.

One example of the latter held within the Firetrail S3 Global Opportunities fund is Schneider Electric, a French company that provides products and services for energy efficiency and management. This is a solution that can be implemented now, as an immediate solution.

Schneider Electric helps its customers reduce their electricity consumption and carbon footprint by offering solutions such as smart meters, sensors, software, automation, lighting, heating, cooling, and electric vehicle charging. Schneider Electric benefits from growing demand for energy efficiency solutions from various sectors such as buildings, industries, data centres, and infrastructure. Schneider Electric also has a diversified geographic exposure and a solid financial performance.

S3 Characteristics are important!

We believe that decarbonisation is important, but we also believe that we need to approach investing in the sector in a pragmatic way. We are not interested in chasing popular or overvalued stocks that may not deliver on their promises or expectations. We are interested in finding undervalued or overlooked stocks that offer sustainable earnings and cashflows, sustainable business models, as well as sustainable positive change.

As one company executive we met recently said: "One of the most important facets of sustainability is remaining a going concern". We think this is very true in the current environment.

Funds operated by this manager:

Firetrail Absolute Return Fund, Firetrail Australian High Conviction Fund, Firetrail Australian Small Companies Fund, Firetrail S3 Global Opportunities Fund, Firetrail S3 Global Opportunities Fund (Hedged)