Nilesh Shah’s view on Economy and Markets

Author: iFAST Research Team

This is a brief outline of the conference call held on 16 November 2010 with Nilesh Shah, Deputy

Managing Director, ICICI Prudential Asset Management Company (the AMC). The topic of the call was

ICICI Prudential AMC’s views on Macro Economy, Equity and Fixed Income Market and outlook on ICICI

Prudential Regular Savings Fund.

Key Highlights

• Bullish on the long-term India story but in the short term, India equity market looks expensive as

compared to its historical valuation, as well as relative to its peers

• Expects market to be range bound from 16,000 to 18,000 levels

• Recommends to invest in staggered manner whenever the market corrects

• Expects RBI not to change rates in December policy meet and would do one more rate hike in

January or later.

• Finds interest rate attractive in the short-term; investors can lock their money in Fixed Maturity

Plans (FMPs) or Interval Funds. In case of duration funds, expect long-term G-Sec yield to come

down by early 2011.

• Recommends investing in staggered manner in G-sec and Income funds when yields are above

8%

• Bullish on the infrastructure theme as compared to consumption theme

Macro Economy Perspective

Mr. Shah shared that, ‘Global markets are reacting like buy on rumour and sell on fact.’

From August 2010, markets were expecting second round of Quantitative Easing (QEII). As a result, this

expectation pulled up prices of equity, commodity and risky assets, depreciated the dollar, and the yield

on debt securities went down. On 4th November, Fed did announce the QEII which was in line with

market expectation or slightly above market expectation, but subsequently markets started to sell off.

Yield on 10 year US government paper went up from about 2.5 % to just below 3%, the commodity

prices corrected and the US Dollar bounced back.

However, the earlier problem in countries like Portugal, Ireland, Italy, Greece and Spain has resurfaced,

the Credit Default Spread (CDS) of Ireland and Greece is rising again. Ireland has declared 30%+ fiscal

deficit to GDP, while Greece has declared 15% fiscal deficit to GDP. And as earlier problems are coming

to light again, the markets are becoming jittery.

Mr. Shah is of the view that the global economy is not deteriorating as expected by markets since the

Fed has provided sufficient measure in terms of low interest rate and sufficient liquidity. Overall global

economy will be in status quo for some time rather than deteriorating or improving very fast. This will

benefit India as commodity prices will remain benign, liquidity will remain high, interest rate will remain

low, and global investors will continue to search for growth and opportunity and will flock to India.

Indian Economy

Mr. Shah is of the view that the Indian economy is witnessing some positives and some negatives.

Positives

• Inflation has started coming line with expectation after 8 to 9 months, and hopefully from

current levels inflation would come down.

• The forex reserve of India has touched US$300 billion; the flows are more from Foreign

Institutional Investor (FII) flows rather than Foreign Direct Investment (FDI) flows though.

• There was also slight reduction in trade deficit at about US$10 billion. Though the deficit from

both current account and trade account is running high, the recent trade has indicated that

there could be some contraction going forward on both current account and trade account

deficit.

Negative

• Indian Industrial Production (IIP) numbers came at 4.4% as against expectation of 6.4%. This is a

worrying factor - if India is growing why the same is not reflected in IIP numbers.

Overall economy is expected to grow at 8% to 8.5%. Inflation should be trending down, interest rate

should remain range bound with yield falling on shorter end of the curve if RBI provides liquidity,

currency should remain range bound, and overall growth scenario should remain conducive.

Fixed Income Market

Mr. Shah is of the view that liquidity in the system is extremely tight since May 2010. The current

illiquidity amounts to the tune of INR 100 thousand crore. This is primarily because government is sitting

on a surplus of INR 80,000 to 90,000 crore on account of 3G auction payment, tax collection and low

spending. In its monetary review policy RBI has indicated that it is comfortable with liquidity shortage of

+ or - 1% Net Demand Time Liquidity (NDTL) which translates to roughly INR 50,000 crore. Current

illiquidity is far higher than comfort zone. RBI has following tools available to provide liquidity - CRR cut,

Open Market Operation (OMO) for buying back of bonds, and Foreign Exchange (FX) intervention in the

form of buying Dollar and supplying Rupee. RBI has already done two out of three things in the form of

OMO and FX intervention however the amount of both this operations has been very small.

The AMC views that the system cannot remain illiquid for very long and if this continues for a prolonged

period of time, it could affect the economy. Mr. Shah was of view that RBI is cognisant of the fact and

will provide liquidity in the system though FX intervention, CRR cut and OMO operation even though

they have denied the same recently. RBI could also cancel some Treasury bill auctions so that

government does not end up with additional surplus funds.

The AMC is of view that short term rates are very high. RBI would pause instead of hike rates for the

month of December, and it is likely that they would do one more rate hike in January or after that.

Assuming that after another rate hike Repo rate would be at 6.5%, but currently 3 month rate at 8%, 6

month rate at 8.5% and 1 year yields at 8.65% looks very attractive.

So the AMC recommend that current allocation in Fixed Income Space may be:

• 50% of the corpus in Fixed Maturity fund or Interval fund to lock in money at good yield.

• 25% in short-term funds like ICICI Prudential Long Term plan or ICICI Prudential Regular Savings

Fund which focus return from accrual and slight mismatch on duration.

• 25% to be invested in a staggered manner in Income and Gilt funds when 10 year G-sec yields

are over 8%. They expect yield to come down in early April as RBI could increase liquidity in the

system and a low borrowing programme by Govt in next year budget.

Equity Market

The AMC is cautious on the market as markets have anticipated QEII well in advance and are on rising

trend since August 2010. In addition to that, from valuation perspective, on relative valuation India is 2.5

times more expensive than Russia, 1.8 times expensive than Brazil and about 1.25 times expensive than

China as well as expensive to other second tier emerging markets like Columbia, Indonesia, Vietnam,

Turkey, Mexico, etc. So global fund managers would find India expensive and as a result increment funds

flowing from emerging market or global funds would slow down. Also, historically the Sensex has traded

at 14.5X to 15.5X one year forward earnings; whereas currently, we are trading at 17.5X one year

forward earnings. So, overall India is trading at reasonable premium to its historical levels and on a

relative basis too, India looks more expensive than its peer group so there is a need for correction which

could be in the form of price or time correction or both.

Mr. Shah expects that markets may give correction both in terms of price and time, where index may

come down little bit and stay at that level for some time so that fundamentals could catch up by that

time.

Recent Sell Off

In last few days FIIs have been net sellers on account of concern about Ireland, Greece, China, whether

the Fed QEII programme will be effective or not, slowing down of global growth, concern about inflation

which is fuelling commodity prices on higher end, unemployment problem in US which is very sticky and

not falling, Fiscal deficit of US as well as political instability in US. Hence we have seen effect on the

market which has dropped by around 900 points.

The AMC is of view that in the short term, markets would not bounce back very sharply from current

levels because of strong supply coming in primary markets from divestment programme in some of

Public Sector Undertakings as well as Qualified Institutional Placements (QIP) and Initial Public Offerings

(IPO) from private sector. The Government and private companies together is expected to raise US$ 13

billion, which is evident from the offer documents filed with SEBI. FIIs have already pumped in around

US$30 billion this year and another US$13 billion will lead to US$43 billion from FIIs this year, which is

pretty high as compares to the previous record of US$17 billion.

So overall supply and valuation will put a cap on how much markets can bounce back from current

levels. On the down side, there will be good support as worldwide investors are still searching for

growth, with high liquidity in global market and low interest rates. The AMC does not expect markets to

give dip correction as witnessed in 2008 because markets as well as regulators are better prepared than

Jan 08.

The AMC believes fair value of the market to be around 16,000 to 18,000 levels and recommends

investing in a staggered manner in any correction in the market. Though the AMC is cautious on the

short term but on the longer time it is very bullish and India is well positioned for strong growth in years

to come.

Sector Outlook

The AMC is bullish on infrastructure sector as compared to consumption sector. It is of the view that

construction activity has rebounded after high monsoon; though results of cement companies have

been lower than expectation but the rebound on cement stocks has been reasonably good on

expectation of better future. All sectors related to infrastructure like power, telecom, capital goods, and

engineering will see the benefit of orders coming in leading increasing turnovers and added profits. On

consumption sector it is of view that the sector is trading at expensive valuation and is already factoring

in similar strong growth in future years.

Recommended Funds in the Current Scenario:

• ICICI Prudential Dynamic Plan, which had cash & cash equivalents around 35% as on October.

• Large cap Fund: ICICI Prudential Focused Blue chip Equity Fund

• Midcap Fund: ICICI Prudential Emerging S.T.A.R (Stocks Targeted At Returns) Fund and ICICI

Prudential Discovery Fund.

• Thematic Fund: ICICI Prudential Infrastructure Fund

ICICI Prudential Regular Savings Fund

ICICI Prudential Regular Savings Fund is an accrual based fixed income fund. The fund would be divided

in to four components and would be looking at higher accrual.

One component will be invested in Non Banking Financial Companies (NBFC) papers, Commercial Papers

(CP) and Debentures. The average maturity of these papers will range from 12 month to 24 months and

would focus on getting 0.25% to 0.5% higher yield than manufacturing paper of similar maturity.

The second component will focus on pass through certificate (PTC), securitisation against auto loan,

asset backed security, etc. The average maturity of these papers will range from 12 month to 24 months

and would focus on getting 0.25% to 1 % higher yield than manufacturing paper of similar maturity.

The third component will be invested in real estate securities, debentures against security of shares and

other structured obligations. Probably these securities would be unrated and as per the SEBI guidelines

the fund would not invest more than 10% in any one issuer and more than 25% in total unrated security.

Even unrated securities will pass through the same sanction credit requirement process followed at the

AMC. These securities are expected to yield higher return than above mentioned papers.

The fourth component would be invested in PSU bonds and highly rated corporate debentures. The

focus on this would be to provide liquidity to the fund and will be invested with expectation of future

change in interest rate.

The first three components will contribute to the maturity of the portfolio and provide higher accrual

over comparable manufacturing papers. The fourth component will be actively managed and if the view

on interest rate is positive the fund will have average maturity of upto 3 years and if view on interest

rate is negative the average maturity of this component would be 1 to 3 years.

The idea is to create an overall portfolio with average maturity of 3 years in higher yield assets. The fund

is well positioned against existing products as well as FMP launches in the market.

As the fund may have some illiquidity in the portfolio, there is a cap of 5 crore per subscriber as well as a

higher exit load upto 2% in case of redemption before 12 months. This measure will help ensure that

the money invested in the fund is stable.

In the current scenario, as the yields are quite decent, the fund can be looked at to lock some portion of

debt corpus at higher yield without too much credit risk.

Disclaimer

This article is for information purpose only. This article and information do not constitute a distribution, an endorsement, an

investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial

products /investment products mentioned in this article or an attempt to influence the opinion or behaviour of the investors

/recipients. Any use of the information /any investment and investment related decisions of the investors/recipients are at their sole

discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives

of the specific person or group of persons. Opinions expressed herein are subject to change without notice.

Disclaimer by ICICI Prudential Asset Management Co. Ltd.

The views expressed above are those of Nilesh Shah and / or of the AMC. These views are based on the internal analysis / research of the markets and publicly available information. Actual results may significantly differ from the views expressed. These views alone are not sufficient and shouldn't be used for the development or implementation of an investment strategy. It should not be construed as investment advice to any party. All opinions and estimates are as of this date and are subject to change without notice. Neither the AMC, nor any person connected with it, accepts any liability arising from any decisions taken on the basis of views expressed. The AMC does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The recipient of this article should rely on their investigations and take their own professional advice. The recipient shall not print, copy, publish or share this document with any other person without prior consent of the AMC. The sector(s)/stock(s) mentioned above do not constitute any recommendation of the same and the schemes of ICICI Prudential Mutual Fund may or may not have any future position in these sector(s)/stock(s). The portfolio of the scheme is subject to changes within the provisions of the scheme information document of the scheme. Please refer to the scheme information document for investment pattern, strategy and risk factors.

This document contains certain forward-looking statements based on current expectations of ICICI Prudential Asset Management Co. Ltd. (the AMC). Actual results may vary significantly from the forward-looking statements in this document due to various risks and uncertainties. These risks and uncertainties include the effect of economic and political conditions in India, and outside India, volatility in interest rates and in Securities markets, new regulations and government policies that might impact the business of the AMC, the general state of the Indian economy and the demand for credit by commercial enterprises and consumers, and the management’s ability to implement the company’s strategy. The AMC doesn’t undertake any obligation to update these forward-looking statements. This document does not constitute an offer or recommendation to buy or sell any securities or investment in the units of any of the scheme of ICICI Prudential Mutual Fund or any of its subsidiaries or associate companies.

ICICI Prudential Infrastructure Fund (An open-ended equity Scheme. Objective is to generate capital appreciation

and income distribution to unitholders by investing predominantly in equity/equity related securities of the

companies belonging to the infrastructure industries and balance in debt securities and money market

instruments); Exit Load: @; ICICI Prudential Dynamic Plan (An open-ended Equity Fund. Objective is to generate

capital appreciation by actively investing in equity and equity related securities and for defensive consideration in

debt / money market instruments); Exit Load: @; ICICI Prudential Focused Bluechip Equity Fund (An open-ended

equity Scheme that seeks to generate long-term capital appreciation and income distribution to unitholders from a

portfolio that is invested in equity and equity related securities of about 20 companies belonging to the large cap

domain and the balance in debt securities and money market instruments. The Fund Manager will always select

stocks for investment from among Top 200 stocks in terms of market capitalization on the National Stock Exchange

of India Ltd. If the total assets under management under this Scheme goes above Rs. 1000 crores the Fund

Manager reserves the right to increase the number of companies to more than 20. Investments in the Scheme

may have concentration risk, as the Scheme invests in about 20 stocks. Exit Load: @; ICICI Prudential Emerging

S.T.A.R. (Stocks Targeted At Returns) Fund An open-ended Equity Fund. Primary objective is to generate capital

appreciation by actively investing in diversified mid cap stocks. The Scheme will invest primarily in companies that

have a market capitalisation between 100 crores and 2,000 crores. Exit Load: @; ICICI Prudential Long Term Plan

(An open-ended Income Fund. Objective is to generate income through investments in a range of debt and money

market instruments of various maturities with a view to maximising income while maintaining the optimum

balance of yield, safety and liquidity. Exit Load: If the amount sought to be redeemed or switched out, is invested

for a period of - (a) upto 1 year from the date of allotment- 0.75 % of applicable NAV; (b) more than 1 year from

the date of allotment- Nil

ICICI Prudential Regular Savings Fund (IPRSF) is an open-ended income fund that intends to provide reasonable

returns, by maintaining an optimum balance of safety, liquidity and yield, through investments in a basket of debt

and money market instruments with a view to delivering consistent performance. However, there can be no

assurance that the investment objective of the Scheme will be realized. Entry Load Not Applicable; Exit Load: (i) If

the amount sought to be redeemed or switched out, is invested upto 1 year from the date of allotment - 2% of the

applicable NAV; (ii) If the amount, sought to be redeemed or switched out, is invested for a period of more than 1

year from the date of allotment – Nil.

@ Exit Load: If the amount sought to be redeemed or switched out, is invested for a period of - (a) upto 1 year

from the date of allotment- 1 % of applicable NAV; (b) more than 1 year from the date of allotment- Nil

Significant risk factors for debt oriented Schemes: Investments in the Scheme(s) may be affected by risks

relating to trading volumes, settlement periods, interest rate, liquidity or marketability, credit, reinvestment,

regulatory, investment in unlisted securities, default risk including the possible loss of principal, derivatives,

investment in securitised instruments and risk of Co-mingling etc.

Significant risk factors for equity oriented Schemes: Investments in the Scheme may be affected by trading

volumes, settlement periods, volatility, price fluctuations and risks such as liquidity, derivative, market,

currency, lending & borrowing, credit & interest rate.

The above are only the names of the Schemes and do not in any manner indicate either the quality of the

Schemes or their future prospects and returns. Please read Statement of Additional Information and Scheme

Information Document carefully before investing. All investments in mutual funds and securities are subject to

market risks and the NAV of the Schemes may go up or down depending upon the factors and forces affecting

the securities market and there can be no assurance that the fund's objectives will be achieved.