Investment Strategy Equity & Debt, February, 2018
Key pointers on budget numbers The government expects total receipts to grow at 10% in FY2019BE based on 11.5% nominal GDP growth. o FY2019 is likely to see a modest growth recovery, probably in the second half, which should be positive for tax collections. o We believe that the government should be able to stick to its budgeted direct tax estimates on account of tax buoyancy. o However, the GST collections will be crucial for the expenditure plans of the government. The government has budgeted Rs. 7.4 tn as GST collections for FY2019 against Rs. 4.4 tn in FY2018RE. o The FY2019 budgeted collections are seemingly on the higher side. o While the collections could see some buoyancy with better compliance from streamlining of returns, e-way bill, invoice matching, etc., there could be a potential shortfall. The government expects corporate tax revenues to grow at 10%, in line with 10% growth in FY2018. o While tax for corporates (with turnover of up to 250 Cr. as on 31st March 2017) has been reduced to 25%, bulk of the corporate tax collections come from ~7000 corporates which have reported turnover of more than 250 Crs. The government has pegged food subsidy at Rs. 1.7 tn vs. Rs.1.4 tn in FY2018RE. o This could potentially suggest (1) high increases in MSPs for FY2019 and/or (2) higher procurement of food produce under the MSP program. The government has budgeted Rs. 701 bn for fertilizer subsidies, Rs. 50 bn higher than FY2018RE. The government has allocated Rs. 218 bn for subsidy on fuel for FY2019 versus FY2018RE figure of Rs. 207 bn. o However, we estimate fuel subsidy to be higher at Rs. 300 bn. with average crude price of US$60/bbl in FY2019. o It could be even higher, if the crude prices remain at elevated levels. Key takeaways For fixed income The fiscal slippage of 0.3% in the FY18 translates into additional short term borrowing of Rs. 75,000 Crs though treasury bills in FY18. This is much higher than the initial budgeted estimate of Rs. 2,000 Crs. The gross borrowing for FY19 is pegged at Rs. 6.06 Lac Crs. The net borrowing stands at Rs. 4.62 Lac Crs and when adjusted for buybacks, reduces to Rs. 3.90 Lac Crs. These numbers largely remain in line with corresponding figures for FY18. The government also announced intention of setting Minimum Support Price (MSP) at 1.5 times the cost of produce for the crops. As a result, around 5% - 15% increase is expected in the MSP for kharif crops for next season.
Our fixed income view As a base case, we expect inflation to rise to around 6% in 2QCY18 from 5.2% in December 2017. However, inflation is expected to decline from its peak in 2HCY18. We acknowledge upside risks to inflation from high MSP prices, lower rabi output, state governments 7th Pay Commission & HRA implementation and higher crude prices. These factors could tilt the policy cycle towards rate increases from pause, especially if economic recovery was to strengthen and inflation dynamics worsen. If these factors were to materialize, we do not rule out 25-50 bps hikes through FY2019. The government supply of Rs.3.9 Lac Crs is in line with this year but current weak appetite could keep pressure on absorption. A hike in FII limits, support from RBI in form of OMO purchases could improve the demand supply dynamics. The guidance in the upcoming monetary policy committee on 7th February will be keenly watched as fiscal consolidation was repeatedly stressed by MPC. Also, the MPC commentary on the quality of the budget spending and inflationary impact of the planned MSP hike would be key for further market direction. Our sense is MPC is likely to maintain a hawkish tone in response to the above mentioned budget announcements, elevated global crude prices and US treasury yields. Yields are likely to stabilize around the monetary policy and some risk appetite could return to market participants if the RBI is not overly hawkish in its guidance. Debt Portfolio Strategy From a valuation standpoint, while the long end bond strategies like dynamic, gilt and bond funds look attractive, we maintain caution in these strategies as fiscal slippage along with upside inflation risks could keep yields elevated. The core allocations in fixed income should be oriented towards short end strategies which is significantly pricing rate hikes already. The strategies should include combination of high quality passive accrual and high yield accrual. Fixed maturity plans with selective credit underlying s should be evaluated to take advantage of current elevated yields.
Yield movement in different buckets of bonds over last one month Segment As on 1st Jan 2018 As on 1st Feb 2018 Bank CDs CPs Bank CDs CPs Change in Bps - CD Change in Bps - CP 3 Month 6.29 7.2 7.2 7.76 92 56 6 Month 6.95 7.41 7.38 7.89 43 48 12 Month 7.05 7.6 7.5 7.98 45 38 Segment G-Sec AAA Corporate Bond G-Sec AAA Corporate Bond Change in Bps - G-Sec Change in Bps - AAA Corporate 1 Year 6.31 7.38 6.67 7.71 36 33 3 Year 6.77 7.68 7.15 7.75 39 7 5 Year 7.13 7.7 7.5 8.01 37 31 10 Year 7.34 7.94 7.6 8.31 27 37 15 Year 7.52 8.16 7.7 8.2 18 4 28 Year 7.72 NA 7.86 NA 15 NA 35 Year 7.62 NA 7.75 NA 14 NA Source: Bloomberg
Equity Strategy Key takeaways For equities The imposition of long term capital gains tax on shares and mutual fund units could be a short term negative for investor sentiment, although the Budget has grandfathered all capital gains up to 31st Jan 18. Hence, market could witness higher volatility in the short term as investors come to terms with the new tax regime. The Govt. s policy thrust on rural development, agriculture, and infrastructure with focus to revive the economy, is a likely to be a positive for the underlying sectors. Our equity view - earnings growth expectations & valuations Going forward, we believe market will focus on earnings growth trend for the remainder of FY18 and growth expectations for FY19. In prevailing scenario, based on 1 year forward PE, the Nifty Free Float Midcap 100 index is trading at a 20% premium to Nifty50 index vis-à-vis a discount of 6% based on historical average (last 10 years). Index 1 year forward PE(X) Nifty50 (at level of 10760) 17.83 Nifty Free Float Midcap 100 (at level of 19760) 21.40 Source: Bloomberg Domestic Institutional flows into equities continue to remain strong In CY17, net investments by domestic equity funds were more than twice that of FIIs. *Net sales in equity funds continue to be strong. Source: KIE, AMFI Key Triggers Net Investments (USD mn) Calendar Year FIIs Equity MFs CY17 8014 18322 CY18 (Jan'18) 2039 1160 Positive Expectation of higher earnings growth in FY19 Continuing strong flows from domestic equity funds Negative Weak domestic macros (higher inflation, interest rates) Higher crude prices State elections in CY18 Rising global bond yields
Equity Portfolio Strategy We continue to maintain our NEUTRAL stance on Equities. Within Equity Mutual Fund portfolio, we recommend allocation as follows; % Allocation Equity Fund Rationale category 50% Large Cap Funds Large caps trading at relative better valuations to Mid & Small caps 50% Opportunistic Funds (Multi Cap) Deployment Strategy for Fresh Flows Allows fund manager to invest across market capitalization basis stock-specific opportunities Equity MFs (Large Cap & Opportunistic funds): At the current level, we advise new investments in Mutual Funds to be deployed 33% in lumpsum and subsequent in tranches via SIPs/STPs.
Annexure 1: Impact of budget on different category on instruments Impact of budget on different category on instruments Instrument Taxation Change in Budget Impact Analysis Action Point* Arbitrage Funds Liquid Funds / Ultra Short Term Funds Equity Savings Scheme Monthly Income Plans (MIPs) Equity Mutual Funds Dividend Distribution Tax (DDT) of 10% will now be applicable Although dividend options of Arbitrage funds are expected to give better post tax returns than dividend options of liquid / ultra-short term funds, attractiveness of Arbitrage Funds over Liquid / Ultra Short Term funds has reduced No change NA Status quo Dividend Distribution Tax (DDT) of 10% will now be applicable No change Dividend Distribution Tax (DDT) of 10% will now be applicable Attractiveness of dividend Payout options of equity savings schemes to generate regular liquidity has reduced due to the DDT. The differential in taxation for the equity component of MIPs w.r.t. equity mutual funds has reduced However, effective tax rate on Equity component is expected be higher for MIPs (assuming 9.5 % p.a. return for equities). Attractiveness of dividend Payout options of equity mutual funds to generate regular liquidity has reduced due to the DDT. For MAT paying companies, dividend options might still be better because DDT is still lower than the MAT rate. However, risk of Section 14 A disallowance needs to be considered In case large amounts are redeemed from Arbitrage funds, the returns could see a negative MTM impact. Existing / New investors with investment horizon of more than 90 days can continue to hold /add Status quo For existing investment in Dividend schemes where short term tax is not applicable (except for MAT companies), prefer to switch to Growth options by 31st March because: - Regular dividend tax reduces the compounding effect - Since DDT will be deducted by the MF in its own books, benefit of offset against possible losses will not be available If regular liquidity is required, prefer systematic withdrawal from growth options (where long term is completed) rather than dividend payouts For all equity mutual funds which have a long term gain from 1st Feb 18 to 31st Mar 18, one can look at booking the long term capital gains before 31st Mar 2018
Instrument Taxation Change in Budget Impact Analysis Action Point* Balanced Funds ETFs Fund of Fund (Offshore) *Indicative. Dividend Distribution Tax (DDT) of 10% will now be applicable No change, continue to be taxed as debt mutual funds Debt portion of Balanced Funds will now be taxed at 10% without indexation as compared to 20% with indexation for pure debt mutual funds. Effective tax rate on Debt component is expected to be higher for Balanced Funds. Turnover in portfolio will see a nominal cash flow impact due to tax every year The differential in taxation w.r.t. domestic equity mutual funds has reduced Attractiveness of Balanced Funds has reduced. Therefore, prefer to redeem from Balanced funds which have completed 1 year and invest separately through Equity & Debt mutual funds Status quo Can be evaluated on the merit of the underlying strategy.
Disclaimer The aforesaid is for information purposes only and should not be construed to be investment advice under SEBI (Investment Advisory) Regulations. In the preparation of the material contained in this document, Kotak Mahindra Bank has used information that is publicly available, including information developed in-house. Some of the material used in the document may have been obtained from members/persons other than the Kotak Mahindra Bank and/or its affiliates and which may have been made available to Kotak Mahindra Bank and/or its affiliates. Information gathered & material used in this document is believed to be from reliable sources. Kotak Mahindra Bank however does not warrant the accuracy, reasonableness and/or completeness of any information. For data reference to any third party in this material no such party will assume any liability for the same. Kotak Mahindra Bank and/or any affiliate of Kotak Mahindra Bank does not in any way through this material solicit any offer for purchase, sale or any financial transaction/commodities/products of any financial instrument dealt in this material. All recipients of this material should before dealing and or transacting in any of the products referred to in this material make their own investigation, seek appropriate professional advice We have included statements/opinions/recommendations in this document which contain words or phrases such as "will", "expect" "should" and similar expressions or variations of such expressions, that are "forward looking statements". Actual results may differ materially from those suggested by the forward looking statements due to risks or uncertainties associated with our expectations with respect to, but not limited to, exposure to market risks, general economic and political conditions in India and other countries globally, which have an impact on our services and / or investments, the monetary and interest policies of India, inflation, deflation, unanticipated turbulence in interest rates, foreign exchange rates, equity prices or other rates or prices, the performance of the financial markets in India and globally, changes in domestic and foreign laws, regulations and taxes and changes in competition in the industry. By their nature, certain market risk disclosures are only estimates and could be materially different from what actually occurs in the future. As a result, actual future gains or losses could materially differ from those that have been estimated Kotak Mahindra Bank (including its affiliates) and any of its officers directors, personnel and employees, shall not liable for any loss, damage of any nature, including but not limited to direct, indirect, punitive, special, exemplary, consequential, as also any loss of profit in any way arising from the use of this material in any manner. The recipient alone shall be fully responsible/ are liable for any decision taken on the basis of this material. The investments discussed in this material may not be suitable for all investors. Any person subscribing to or investing in any product/financial instruments should do so on the basis of and after verifying the terms attached to such product/financial instrument. Financial products and instruments are subject to market risks and yields may fluctuate depending on various factors affecting capital/debt markets. Please note that past performance of the financial products and instruments does not necessarily indicate the future prospects and performance thereof. Such past performance mayor may not be sustained in future. Kotak Mahindra Bank (including its affiliates) or its officers, directors, personnel and employees, including persons involved in the preparation or issuance of this material may; (a) from time to time, have long or short positions in, and buy or sell the securities mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation in the financial instruments/products/commodities discussed herein or act as advisor or lender / borrower in respect of such securities/financial instruments/products/commodities or have other potential conflict of interest with respect to any recommendation and related information and opinions. The said persons may have acted upon and/or in a manner contradictory with the information contained here. No part of this material may be duplicated in whole or in part in any form and or redistributed without the prior written consent of Kotak Mahindra Bank. This material is strictly confidential to the recipient and should not be reproduced or disseminated to anyone else This material is not a research report as per the SEBI (Research Analyst) Regulations, 2014. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.