Kanishke Mannakkara, Managing Director at Capital Alliance Investments Limited, discusses the twin threats of inflation and rising interest rates in 2022 and what investors and businesses need to do.

With a career spanning 18 years working across multiple countries and cultures from asset management and corporate finance to design and product innovation, Mannakkara shares insights on how to navigate potentially another challenging year and how CAL has the means to help investors and businesses. He also paints a picture of CAL’s bold plan to develop and scale-up frontier capital markets.

Can you give us a brief overview of the economy and capital markets in 2021 and the outlook for 2022?

One of the defining features of the investment landscape globally over the last 18 months has been the post-Covid expansion of money supply. Although justifiable to a degree, it is unprecedented in magnitude. And that expansion in money supply has driven up asset prices significantly.

Let’s put this into context from a Sri Lankan perspective: in January 2019, banks and other top-rated issuers were offering 16% on five-year debt instruments like bonds or fixed deposits. Two years later, the offered rate on the same tenure was around 6-7%. The loose monetary conditions had a big impact in bolstering capital markets.

Another key feature has been the increasing influence of retail investors in stock markets and exchanges globally. A new set of investors have become very active in stocks and other asset classes like cryptocurrency, and you see them taking a very different approach compared to ‘traditional’ investors. Ideas are widely shared and to an extent, crowdsourced via social media, and you see a much more aggressive trading style. Rapid advances in digital technology and cryptocurrency, and working from home have contributed to this cultural shift worldwide, and we are seeing the same thing in Sri Lanka on the CSE. Retail investors are much more dynamic and demanding than they ever were, and they are playing a big role in determining share prices.

However, we are looking at a very high likelihood of this loose monetary policy tapering off over the course of 2022. In my view, we are very likely to see markedly higher interest rates over the next six to eight months in Sri Lanka coupled with a significant increase in inflation. You could argue that inflation will be the precursor to rising interest rates. It will be a situation where if you want to avoid unsustainable inflation, then interest rates will need to go up very significantly, very fast.

With the increase in interest rates and inflation, you may see a once-in-a-decade opportunity on fixed-income assets where you can potentially lock in investments at very high yields. There is a caveat because, in the short term, we are likely to endure very high inflation and low real interest rates. In this context, there could also be opportunity in ‘real’ assets which give some protection against inflation.

And when you’re thinking about capital markets in Sri Lanka in 2022, you cannot ignore the serious headwinds the economy is facing right now. Investors need to be prepared for a potential systemic shock, driven by external pressure on the economy at some point next year-potentially in Q2 or Q3.

With the increase in interest rates and inflation, you may see a once-in-a-decade opportunity on fixed income assets where you can potentially lock in investments at very high yields

Where do you see interest rates and inflation heading and their impact on the economy?

We believe interest rates will reach the high teens, and investors willing to go along may be able to see yields closer to 20%. Inflation, already at 10%, will most likely reach the mid-to-high teens. The thing about inflation is once it starts picking up and building steam, it’s extraordinarily difficult to contain. And it takes time. With inflation in the mid-teens, interest rates will also have to get into the high teens. If that doesn’t happen-if interest rates don’t go up that high, we could see dramatically higher inflation.

For investors considering their asset allocation strategy, providing protection for portfolios, and guarding against inflation, how should they approach investing in the year ahead?

In investing, crisis equals opportunity. Sometime in 2022, I think there will be an opportunity to profit from the volatility we are likely to see.

One could be buying government securities with a 20% yield, hold, and book profits as and when interest rates start to cool and get back to where they should be. Equities could experience a short sharp decline when interest rates spike, but that could unleash buying opportunities that result in attractive gains down the line. We saw this soon after the Covid outbreak when stocks fell but quickly recovered. Similarly, there could be opportunities in real estate and private equity. From an investor’s perspective, one needs to maintain sufficient liquidity and have the ability to jump into the opportunities that will present themselves.

Just as importantly, you also need to be mentally prepared to make the mindset shift from being defensive to extremely aggressive, really fast. When approaching an investment strategy for 2022, it will be crucial for investors to switch from risk-off to risk-on at the right time and have exposure to multiple asset classes. I don’t think there will be one single asset class solution to wealth management over the next three years. Investing should be approached from multiple angles of listed equities, fixed income, private equity, and real estate. All four will play a key role, I believe.

How should businesses approach investing or raising capital? What are their options?

The circumstances facing each business is different. The obvious move is to raise as much capital as possible before interest rates escalate. From a liquidity perspective, it’s not dissimilar to individuals. Businesses need to be liquid as much as possible and maintain healthy balance sheets. Build up liabilities in such a way that does not compromise short term cash availability. They will also need to be mindful of the possibility of further supply chain disruptions. To sum up, businesses need to stock up on cash and stocks heading into 2022.

Is a stock exchange listing viable to raise capital at this stage?

Going public with a listing is a big decision for any business and should not be driven by short term capital needs. Listing is about more than that. It is about understanding what is right for the business in the long term. However, if a business is ready to go public, now is a good time because the market is ready, and you can get a decent valuation. If a company is on the fence about listing, say they are 50/50 about going public, my recommendation is to go for it! However, a listing would be ideal before the second quarter of 2022. Beyond that, we will have to wait and see how the economy and markets unravel.

I’m not saying there will not be an opportunity even after that, but it’s too early to call that. Opportunities to raise debt capital will also emerge by then. There is a lot of money in the system, and that money is looking for a home. I think there is an opportunity for corporates to structure debt in a manner that appeals to different types of investors. Obviously, in the current context, raising long-term debt with a fixed rate would be ideal, but companies need to be attuned to market appetite as well. I don’t think there will be too many people today looking for long term investments with fixed rates.

As a corporate, I would prioritize cash flow over P&L for the next year or two. This may mean taking floating rate loans to bolster cash reserves. Don’t be nervous, to go for floating rate options if that’s what the market is demanding. Having cash in your balance sheet during a time of crisis is more important than worrying about your finance costs on that debt. It is not as if you will take debt from zero to 200. It will be that you had 100, and now you’re going to take it up to 150-160 to maintain that slightly larger cash-or stock-balance.

Many will talk about the economic risks next year, but I think it’s also crucial to focus on the opportunity that comes after that. And that opportunity is going to be huge. There’ll be a huge opportunity to capture market share and acquire competitors. Having the cash and balance sheet strength to seize those opportunities as they manifest themselves when everybody else is running for the hills, could set the foundation for your growth over the next five years.

Looking at the big picture, tell us about CAL’s suite of solutions and services and how CAL can help its clients navigate the emerging macroeconomic storm?

As an investment bank, we have operations in bond trading, stockbroking, corporate finance, asset management and private equity.

What we offer through this is a suite of products that feed off each other whilst maintaining strict compliance, client confidentiality and Chinese Walls. We bring high-level capability and expertise to the table with a regional/international focus and a Sri Lankan flavour. Our culture and values differentiate us from our peers. We never offer any service or solution to a client that we would not to our own families. Creating great customer experiences, giving them good returns, and honouring their trust are our priorities.

CAL has an established track record of innovation and dynamism, being the first to introduce a range of different products. We have launched private equity products and real estate solutions, something other asset management businesses in Sri Lanka do not traditionally cover. CAL has already adjusted its value proposition to meet precisely those emerging portfolio diversification needs that I spoke of earlier.

We have invested heavily in technology. The innovative front-end platforms we have developed are the most visible elements of this, but there is also a lot of back-end data gathering and analysis that helps differentiate our decision making from our competitors. The CAL Portal is already helping us democratize capital markets in this country, and we are seeing some great results. A prime example is the IPO portal which has been a big hit with retail investors.

While all these things set us apart, we are also building CAL into a multinational frontier market investment bank. That gives us rich perspectives from the different countries that we operate in, including deeper connections and much more scale, which is one of the things that frontier markets lack.

By operating in multiple countries and feeding those frontier markets as a single unit, you suddenly build the scale that will attract global investments. Fund managers out of international global financial hubs may not be interested in Sri Lanka and it’s $80 billion economy as a standalone investment destination. But things become very interesting if we can include Sri Lanka within a portfolio of frontier markets with a combined GDP of $1 trillion. Having already commenced this journey, we believe we can create a presence in economies with a combined GDP of over $1 trillion in the next four to five years. Our focus right now is to consolidate our presence in Bangladesh and perfect the model of creating profitable overseas operations. Our plan is to be present in five countries in five years’ time.

What do you want to achieve? What is the purpose of CAL?

So capital markets, in our view, are a necessary element of prosperity. You cannot have prosperity or sustainable economic growth without capital markets. And frontier economies don’t have developed capital markets by their very definition. We enjoy an advantage having built a successful investment bank out of Sri Lanka, which has a relatively developed capital market for a frontier economy. The stock market is over 100 years old, and the bond market is solid. We now have REIT legislation which is very rare for frontier markets. So we are ahead compared to peer economies. That gives us an edge in technical capabilities over somebody operating in, for example, Laos, Bangladesh or Myanmar. At the same time, we understand the nuances and frustrations of working in a Frontier market the way somebody operating out of London or Singapore may not.

We have created a profitable business in this $80 billion economy, and we know how to unlock value out of the smaller ticket sized transactions you see in Frontier markets. We are working on building the scale necessary to attract global investment inflows, so that we can become a conduit between those funds and investment opportunities over here. We see ourselves being the connect between multiple frontier markets in this equation. If you were to put five frontier markets together and create a $1 trillion market, you suddenly create one of the 20 largest economies in the world, and that opportunity is very exciting. With that comes the capability to transform the capital markets landscape in these countries.

Capital markets are about matching demand for capital in supply. On the demand side, there is no lack of it in the frontier markets we are talking about, but that demand is too fragmented. You are talking about ticket sizes that are not attractive or economical for a fund manager sitting in New York, London, Tokyo or Singapore because they are used to dealing in multiples of $100 million. That is where CAL steps in. We will package multiple projects and say, look, here’s a billion-dollar portfolio. But within that portfolio, there are many different things that each needs small amounts of money that we can evaluate on the ground, something the existing global frontier market funds aren’t currently able to do. We want to create that boots-on-the-ground capability across all these frontier markets to curate and structure innovative products, and then market them as a whole to funds managed from global financial centres. In doing so, we are fulfilling our purpose as CAL, to better the lives of people living in Frontier economies.

By operating in multiple countries and feeding those frontier markets as a single unit, you suddenly build the scale that will attract global investments

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