Key Investment Themes for 2011-India Perspective

Author: iFAST Research Team

Debt Market Scenario

Rising interest rates

The Reserve Bank of India (RBI) increased

the Repo Rate and Reverse Repo Rates by

150 basis points and 200 basis points (bps)

respectively in 2010. The monetary

tightening was an outcome of inflationary

pressures from domestic side as well as

global factors.

Going ahead, RBI may find it difficult to

meet the inflation target of 5.50% by

March 2011 and inflation would persist for

some time. Hence, we expect that the

Central Bank would increase Repo and

Reverse Repo rates further by 50 bps in

the first three months of 2011.

Although inflation is a major concern now, we are of the opinion that the inflation data will show

moderation in the second half of 2011 on account of good monsoon and base effect. In addition, we also

expect the growth in the economy to moderate next year, FY 2011-12, which will make the Central Bank

to go in for a pause in the rate hikes in the second half of 2011.

Liquidity crunch

At present, Indian debt market is facing huge liquidity crisis. In the month of November and December,

banks have been borrowing daily, on an average, more than INR 1 trillion and INR 1.2 trillion respectively

from RBI.

The liquidity crunch has been on account of following factors:

1. Large Government surplus averaging INR 840 billion gained from 3G auction and buoyant tax

collections that has been lying with the RBI since the second quarter review of November 2010

2. Huge equity issuance in the form of Initial Public Offering and Follow on Public Offers and

3. Sluggish growth in bank deposits despite the accelerating credit growth

We expect that liquidity to remain tight for some more time, but in the run up to March 2011, the

borrowing of the government for FY 2010-11 will be completed and the huge government surplus lying

with the RBI will be infused into the economy in form of government expenditures. These factors should

ease the short-term and long-term rates.

The Union Budget FY2011-12 would have a significant impact on fixed income markets in 2011. Several

factors such as the borrowing calendar of the government along with the fiscal deficit roadmap and the

disinvestment plans for 2012 will be the crucial factors that would decide the movement of bond yields.

High Yields

Due to the six continuous rates hikes by the

Reserve Bank of India (RBI) in 2010 and the

severe liquidity crunch faced in the system

since the last few months, the bond yields

have increased sharply. In the last 18 to 20

months, yields on the short-end and the long-

end of the curve have significantly moved

higher. On the 10 year G-Sec paper, the yields

have risen by 180 basis points (bps) and on

the Certificate of Deposits of time period

between 3 and 12 months, the yields have

risen by 400 to 500 bps. The yields on 3-12

months Commercial Papers have also risen by

400 to 550 bps.

FII limits eased

The FII limit in the bond market has been increased to US$30 billion and the impact of this measure

would be seen in 2011. The increased FII limit will definitely help in easing the liquidity situation in the

market. The FII inflows into the Indian market are approximately US$9 billion (Year-to-Date) as against

US$1 billion in 2009.

Implication for Investors

Fixed Maturity Plans

• iFAST expects the short-term rates to go down in the second half of 2011 with RBI going slow on

rate hikes and easing of liquidity. In this scenario, it would be advisable for investors to lock in

money in Fixed Maturity Plans (FMPs) as they can take advantage of prevailing high yields. Plus,

there is negligible impact of interest rate movements as the portfolio is held till maturity. In

addition, they are tax efficient, as they are taxed at 10% without indexation and 20% with

indexation. Thus, the returns given by the FMPs post tax would be more than net yield from

Fixed Deposits. There is also double indexation benefit, if investments overlap 2 financial years.

Thus, investors having a time horizon of 3 months to 2 year time horizon can consider Fixed

Maturity Plans (FMPs).

Ultra Short Term Funds

• Investors whose money idles in their savings account for over a month can consider Ultra Short

Term Funds as an alternative. The return earned on a savings account is only 3.5% per annum,

while for Ultra Short Term Funds, an average return falls in the range of 4.5%-5% or at times

even more. From taxation side, the interest income from savings account is added to the

individual’s income, whereas for Ultra-Short Term, the Dividend Distribution Tax is 14.16%

including surcharge and education cess.

• Our recommended Funds in the Ultra-Short Term Funds are Birla Sun Life Ultra Short-Term

Fund, Reliance Money Manager Fund, BNP Paribas Money Plus Fund,Canara Robeco Treasury

Advantage Fund and Templeton Ultra Short-Term Fund

Outlook on Equity

Neutral on Indian Equities on account of the following factors:

� Sensex is overvalued in terms of historical and relative valuation. Historically, the fair P/E of

Sensex has been around 17X, whereas we are currently trading above the historical levels.

Expected EPS of Sensex by March 2011 is around 996 which translate into a P/E of 19.94X.

� Year-to-Date (as at 30 November 2010), FIIs have already pumped in around US$ 28.91 billion

into Indian Equity market. Any reversal in the FII inflows due to the uncertainty in the global

economy could severely impact the Indian market.

� The huge FII inflow has led to Rupee Appreciation, which has reduced the attractiveness of

Indian exports. If the Central Bank resorts to capital controls to hold the inflows, then there

would be a sharp correction in the Index.

� In the year 2010, RBI has hiked rates six times, the impact of which will be seen in terms of

moderation in the GDP data in the coming quarters, which will affect the profitability of Indian

corporate sector.

Implications for Investors

Mid-cap Funds

• Investors should look at mid-cap funds as this category is expected to deliver better returns than

their large cap counterparts. This is because the midcap index is currently trading 25% below its

previous all-time highs. In this scenario, fund managers will definitely look out for quality stocks

in the mid-cap space which are available at attractive valuations.

• Our Recommended Funds in the Mid-cap Funds are HDFC Midcap Opportunity Fund, Sundaram

Select Midcap Fund, Birla Sun Life Midcap Fund and DSP BlackRock Small & Midcap Fund.

Infrastructure and Banking Sectors

• We are positive on the infrastructure and banking space. Although the infrastructure sector has

underperformed in 2010 on account of reduced capital expenditure and global recession, we

feel that the expected GDP of 8.70% in 2011 can be achieved only with huge spending on this

sector. In the Twelfth Five year Plan (2012-2017), Government is planning to spend about US$1

trillion into the infrastructure space. If infrastructure is the favored sector with the government

then it will be the banks, which will be the key financiers of the infrastructure projects. Although

RBI expects credit growth to be around 20% by 2011, we are of the opinion that the figures will

be higher on account of companies reviving their capital expenditure plans and higher

disposable income with the masses. The credit growth as at 3 December 2010 has already

reached 22%.

• Our Recommended Funds for the Infrastructure and Banking Sectors are ICICI Prudential

Infrastructure Fund, DSP BlackRock T.I.G.E.R Fund and Reliance Banking Fund.

FMCG and Pharmaceuticals Sectors

• FMCG and Health Care sectors have outperformed BSE Sensex in 2010 and we expect these

sectors to continue their outperformance in 2011 at the back of the strong consumption growth

especially in the rural segment. Plus, there is growth potential in the generic market along with

the consolidation that is expected in the Pharmaceutical space.

• Our Recommended Funds for the FMCG and the Health Care categories are Franklin FMCG Fund

and Reliance Pharma Fund.

Global Funds

• Since global corporate earnings are expected to hit record highs by the end of 2012, we advise

investors to take exposure to global funds. iFAST is of the view that the global economy will

continue to recover in 2011 as well, and we are very positive on the emerging markets and

believe that countries like China will be the main drivers of global economic growth. Investing in

global funds is relatively new to Indian investors. Most of the Indian investors have a

concentrated India portfolio largely due to the fact that mutual fund / investment offerings in

the country have been centered on the domestic market. Now that more international funds

have come in through the feeder funds route, we are of the opinion that entering into these

funds will not only help in geographical diversification, but also reduce the overall portfolio risk.

• Our Recommended Funds in the Global Funds categories are Mirae Asset China Advantage Fund

and Principal Global Opportunities Fund.

Disclaimer

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