Fund Manager Commentary October 2018 Indian Equity & Fixed Income Market Overview Market sentiments turned weak during September Equity markets saw heightened volatility during the month and the performance suffered mainly on the back of domestic factors. Market indices BSE Sensex and NSE CNX Nifty were down 6.2% and 6.4% respectively and the broader market performance suffered much more. S&P BSE 200 index was down 8.1% while BSE Midcap and Smallcap indices lost 12.4% and 15.9% respectively. Global crude oil prices increased by about 6.9%, while INR depreciated by another 2.1% during the month. Market sentiments were also dented by the rating downgrade of AAA rated group to D and concerns of liquidity issues in the NBFC space. The same has been further accentuated by seasonal advance tax outflows and macro concerns on rising crude and a depreciating currency. The RBI took measures to address the system liquidity issue and conducted Rs.100 bn of Open Market Operations or OMOs while additional OMOs are on the anvil. Government also reduced its borrowing programme for FY19 by Rs. 700 bn and allowed additional 2% (from 11% to 13%) of SLR for the purpose of calculating Liquidity Coverage Ratio (LCR) for banks. During September, the government announced a slew of measures aimed at boosting capital flows and also to support INR. Some of these included removal of exposure limits on FPI investment in bonds, exemption from withholding tax for Masala bond issuance for the current fiscal, reduction in minimum maturity for manufacturing firms ECB issuance, mandatory hedging requirements of infrastructure ECB issuances, removal of restrictions on Indian banks market making process in Masala bonds etc. The government also announced incremental import tariffs on 19 items amounting to USD 13 bn in a measure aimed at containing the Current Account Deficit. On the monsoon front, the cumulative rainfall received this year has been weaker than anticipated. The South - West monsoon season (i.e. June-September) recorded rainfall at 91% of the long period average (LPA). The monsoon season also saw an uneven spatial and temporal distribution of rainfall across the country. However, encouragingly, the reservoir storage levels on a pan country basis stood at a healthy 76% of full reservoir level compared to 66% same time last year.
2 Institutional Fund Flows The Foreign Institutional Investors (FIIs) continued to be net sellers for the second consecutive month and net sold equities worth about USD 1.31 bn in September. On a CY18 basis, FIIs have been net sellers to the extent of about USD 2 bn. Domestic Institutional Investor segment saw strong net buying momentum during the month as insurers also contributed to the net buying trend. The domestic MFs once again led the net inflows for DIIs and as they net bought equities worth about USD 1.09 bn while domestic insurers saw net buying of USD 631 mn during the month. On a CY18 basis, the DIIs have net bought equities worth about USD 12.2 bn, entirely driven by MFs (about USD 12.7 bn of net inflows from them) while insurers have been net sellers to the extent of about USD 0.5 bn. Global Economic Scenario It was a month packed with events and news flows globally. Global crude oil prices inched up further by 6.9% during the month as OPEC and allied producers confirmed they would not ramp up output in response to supply shortfall from other producing countries such as Iran. Trade tariff concerns escalated as the US government announced tariffs on further USD 200 bn of Chinese imports. The tariff will be initially set at 10% (beginning on 24 Sep) and will be raised to 25% in 2019, if a new trading relationship cannot be negotiated by that time frame. As a result, China withdrew from further negotiation efforts leading to concerns of the trade related tensions to linger on for some more time. In an another development, the US Federal Reserve raised interest rates by 25 basis points to 2.0 2.25% target range during the month. There is now anticipation of another hike in December this year followed by three more hikes in 2019 and one in 2020. Monetary policy was no longer described as accommodative, but Federal Reserve stressed that the change in the language may not have bearing on future pace of hikes and it will continue to remain data dependent. Key risks and challenges Month of September saw the market sentiments turning weaker on the back of concerns around liquidity in the system and the resultant correction in financial stocks. The increase in interest rates seen recently is a function of RBI hikes and also liquidity/ demand supply situation in the bond markets. Moreover, some part of the increase in rates also reflect the preference for quality credits in the aftermath of rating downgrade of a prominent group and consequential losses in bond/ credit funds in certain mutual fund schemes. RBI and government have been trying to address the liquidity issue and this may be critical for the stability of markets in the future. RBI has announced couple of OMOs during this month, apart from regular infusion through the repo window. The government and the regulatory agencies are expected to act swiftly to allay stakeholders concerns in this regard. NBFCs with proven business models across cycles with good parentage will continue to get lines of credit in the debt market and from banks. Hence, we think though these conditions might persist for some time, and there can be a tempering of growth and margins for NBFCs; but those with retail focused franchises, differentiated business models, efficient asset liability management can navigate through this volatile phase and are expected to come out stronger. Going forward If we analyse the market performance over the past 1 year or so, there is a clear divergence in the performance of large cap indices to that of mid and smallcap indices. While the large cap indices have traded weak in the past month, they have outperformed the mid and smallcap counterparts meaningfully on a CYTD and 1 year basis. S&P BSE Sensex and Nifty have gained 7.4% & 5.1% respectively on a CYTD basis while BSE Midcap and Smallcap indices have lost 16.4% & 24.4% respectively. Also, till about a month back, even with large cap market indices, it has been a concentrated performance with a few stocks contributing to the outperformance, a trend which is showing a reversal at this juncture. Nifty 50 Equal Weight index, which is a proxy to the broad based performance of Nifty 50 index, is down 3.5% on a CYTD basis (NSE Nifty TR is up 5.1% CYTD), while over the past month, performance of both indices have seen much lesser divergence. We have witnessed a sharp up-move in global crude oil prices from USD 65/bbl to USD 80/bbl so far in CY18. With India importing nearly 80% of its oil requirement, higher oil prices coupled with depreciation of INR (against USD) pose macro headwinds. This has resulted in the worsening of the macro economic variables marginally, after registering a significant improvement post the 'taper tantrum' phase in 2013. The fiscal deficit may move marginally higher (by 20 bps), while the improvement over 2013 is still substantial (about 2.5%). On the external front, CAD has widened while exports growth momentum is yet to pick up sustainably. Higher global crude oil price is a headwind in this connection. Having said that, all of these macro variables are in a far better shape when compared to bouts of crises phases we have witnessed in the past decade. RBI is acting proactively and decisively to manage the inflation effectively as demonstrated by the rate hike decisions. The CPI inflation continues to trend in a comfortable zone (between 4-6%). Also, India s foreign exchange reserve has been steadily rising over the years and we are in a far better position compared to taper tantrum crisis period.
Currently, the NSE Nifty 50 index is trading at about 18.6x / about 15.6x FY19/20 consensus earnings expectations^, which is trending slightly above historical averages. These valuations are at earnings growth expectations of roughly 20% for both the years. However, we have to be mindful of the fact that the corporate earnings recovery cycle which is already underway can potentially lead to meaningful acceleration in corporate earnings growth over the next 2-3 years driven by the favourable base as well as a genuine uptick in domestic demand and consumption. We remain constructive on the India story from a medium to long term perspective. Looking ahead, the GST regime will lead to faster formalization of the economy, broaden the tax base, improve the fiscal situation and improve the ease of doing business. IBC is another key reform that will lead to structural repair in the banking industry and this may go a long way in reviving the credit offtake in the economy, early signs of which we are already witnessing. Government has taken some steps to address the growth issue and the bank recapitalisation and infrastructure push announced are to tackle growth challenges and that will help in hastening the overall economic growth revival process. GDP growth rebound after the twin disruptions of Demonetization and GST implementation provides the optimism and we are entering a high growth phase again. The factors to closely track in the near to medium term would be corporate earnings, RBI s policy actions, election calendar culminating in the general elections, global crude price dynamics, rising trends of protectionism in the developed economies and the interest rate actions in the US. Equity Funds - Investment Strategy Our investment philosophy and portfolio construction follows the proprietary profitability and valuation framework. The emphasis is on identifying companies that are attractively valued relative to their sustainable profitability. In the HSBC Large Cap Equity Fund and HSBC Multi Cap Equity Fund portfolios, we continue to remain overweight on materials, consumer discretionary, industrials and financials. However we have been moderating the extent of our active positioning on sectors as well as on selective names, in conjunction with our overall market view. We are mindful of the concentrated performance on an YTD basis in large cap indices and there could be a case for wider participation to the indices performance going forward. The HSBC Small Cap Equity Fund strategy continues to be more bottom up and the sharp correction in some of the small and midcap names during the year is throwing up some investment opportunities that are now available at more reasonable valuations. ^ Data as on 03 Oct 2018 Mutual Fund investments are subject to market risks, read all scheme related documents carefully. 3
Fixed Income Update While the fixed income markets were on a bearish trend throughout the month driven by the elevated oil prices, nervousness around fiscal slippage and etc., RBI s Open Market Operations or OMO announcement and reduced borrowing calendar provided some relief towards the end of the month. RBI Actions OMO: RBI announced an aggregate OMO purchase of INR 360 bn in the month of October to be conducted in the 2 nd, 3 rd and 4 th week of October. In addition they conducted two OMO purchase of INR 200bn in September taking the total OMO to INR 860 bn (including October). Term Repo: RBI in the last week also announced 14/15 day term repo totaling to INR 925 bn for Sept-October to provide temporary liquidity. RBI in the last week of September allowed banks to reckon an additional 2% of NDTL (Net Demand and Time Liabilities) from Statutory Liquidity Ratio (SLR) for LCR purposes taking the total of SLR holdings which can be reckoned for SLR from 13% to 15%. Borrowing Calendar The government lowered its 2HFY19 borrowing program by around Rs200 bn to Rs2.47 tn against expected borrowing of Rs2.68 tn. Overall FY2019 gross borrowing via dated bonds has been now been reduced by around Rs700 bn (Rs500 bn in 1HFY19 and Rs200 bn in 2HFY19) to Rs5.3 tn, with government increasing its funding requirement through the National Small Savings Fund or NSSF and also reducing its buyback plan. Indicative State Development Loans or SDL calendar for October to Dec 2018 was announced by RBI. The borrowings at INR 1.25 trillion was lower than market expectations and similar to around INR 1.2 trillion announced in the previous fiscal (INR 1.05 trillion actually borrowed). Overall therefore it is expected that the last quarter may have heavy SDL borrowing. GDP & GVA India Gross Domestic Product or GDP and Gross Value Added or GVA data came in higher than expectations at 8.2% and 8.0% vis-à-vis expectations of around 7.6% and 6.5% respectively. This was well supported by manufacturing which grew 13.5% y-o-y (albeit helped by a low base owing to destocking due to GST in the previous year), agri and allied activities which grew by 5.3%. Construction also saw robust growth at 9.5%. On the demand side break-up, private consumption growth was robust at 8.6% y-o-y, better than 6.7% in Q1. Government expenditure growth slowed to 7.6%, while fixed capital formation growth was 10%. GST Total GST collections was at Rs944 bn in August compared to Rs940 bn in July. CGST collection amounted to Rs153 bn (July: Rs153 bn), SGST stood at Rs211 bn (Rs212 bn), IGST at Rs501 bn (Rs499 bn), and compensation cess was at Rs80 bn (Rs76 bn). After allocations from the IGST, CGST for August was at Rs306 bn (July: Rs370 bn) and SGST was Rs350 bn (July: Rs411 bn). Overall GST collections continue to remain below target of at least INR 1trn per month. Inflation August CPI came at 3.69%, lower than consensus at 3.77 versus 4.17% in July. Alongside core inflation has also declined to 5.6% from 5.9% in July. The decline is largely driven by food inflation down to 0.9% y-o-y from 1.7%. Food inflation decline is driven by moderation in prices of most food items like vegetables, fruits, and pulses. While moderation in core inflation albeit driven by a base effect, it is comforting, given the steady rise in crude prices and currency depreciation alongside, the sustainability of the same is under question. IIP IIP for July came in at 6.6% y-o-y versus 6.9% in June. The expansion was broad based with some sequential slowdown in mining and electricity due to slowdown in coal production and contraction in natural gas and crude output. Also capital goods indicated some loss of momentum at 3% versus 9.85 in June while consumer durable and non-durables showed a healthy pick up. Overall, healthy IIP numbers keeps the GDP growth story intact. 4
MSP Indian government announced Minimum Support Price or MSP rates. The MSP rate was largely on expected lines as per the formula specified in the budget. Overall MSP rates for paddy, which is the most widely sown kharif crop was increased by 13%, pulses by around 9%, while few of the other crops saw higher increases. On a weighted average basis (considering weights in CPI index), the MSP increase was around 14% on an average. The overall inflation impact is expected to be between 25 to 60 bps as per estimates of various economists but much will depend on procurement policy. Trade deficit Trade deficit widened to a 5 year high of USD 18 bn in July from USD 17.1 bn in June (revised up from USD 16.6 bn earlier). Exports grew by 14.3% y-o-y compared to 18% in June. Imports grew sharply by 28.8% y-o-y driven by a 57% y-o-y growth in oil imports and 40.9% y-o-y growth in gold imports. Fiscal deficit For the first quarter of FY19, government stood at 68.7% of its fiscal deficit target as compared to 80.8% last year. While it is better than last year driven by higher revenue receipts, some portion of this is driven by March GST (collected in April). Currency Rupee exhibited weakness throughout and has crossed about 73 to USD. Dollar strengthening, oil concerns, global trade tensions and weakness in other emerging market currencies weighed on sentiments. RBI is said to have intervened at various levels including at around 72 but intervention has been sporadic and in small amounts. Liquidity Liquidity was largely in the deficit territory but turned into neutral towards the end of the month. Prospectively, OMOs and 14 day term repos should provide adequate liquidity during the upcoming seasonally tight liquidity season. Going Forward 10 year G-Sec is likely trade around 7.90-8.20% in the near term. In the near term, market will look for cues from oil prices, direction of currency movement and global cues and upcoming RBI policy. Note - GPD, GVA, MSP, Trade Deficit, Fiscal Deficit update as at July / August 2018 Mutual Fund investments are subject to market risks, read all scheme related documents carefully. 5
Disclaimer: Data as at September 2018 except other wise mentioned other date Expressions of opinion are those of HSBC only and are subject to change without any prior intimation or notice. It does not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies that may have been discussed or recommended in this report and should understand that the views regarding future prospects may or may not be realised. Neither this document nor the units of HSBC Mutual Fund have been registered in any jurisdiction. The distribution of this document in certain jurisdictions may be restricted or totally prohibited and accordingly, persons who come into possession of this document are required to inform themselves about, and to observe, any such restrictions. Mutual Fund investments are subject to market risks, read all scheme related documents carefully. HSBC Asset Management (India) Private Limited, 16, V.N. Road, Fort, Mumbai-400001 Email: hsbcmf@camsonline.com www.assetmanagement.hsbc.com/in 6