Equity & Debt Strategy

Equity & Debt Strategy Mid Jan Feb 218

Equity Market Update & Equity MF Strategy

Equity market ended 2 on a high note, Nifty 5 up by 28% in CY Nifty up 3% in Dec, MidCap Index up 6.2% FII flows reversed while MF investments slowed down in Dec 1,6 1,5 1,4 1,3 1,2 1,1 1, 9,9 22, 21,5 21, 2,5 2, 19,5 19, 18,5 9,8 18, 6-Dec- 12-Dec- 18-Dec- 24-Dec- 3-Dec- 5-Jan-18 NIFTY Index BJP won Gujarat Election Strong US GDP leads global rally Nsemcap index 25, cr 2, 15, 1, 5, -5, -1, -15, 21,45 19,188 13,46 12,9 1,664 6,182 1,918 1,586 Sep Oct Nov Dec -9-2,841-6,663-1,764 FII DII excl MF MF December saw higher contribution through Balanced Funds In 2, sectors which had been lagging like Realty, Energy and Infra did well cr 25, 2, 15, 1, 5, 181 8141 15218 5897 1958 7614 14921 9756 % 12 1 8 6 4 2 19.8 4.5 38.7 34.1 NSE sector indices 31.4 29.4 12.2 Sep Oct Nov Dec Equity Balanced -2 Realty Bank Energy Infra Auto FMCG IT Pharma -6.3 Source: Bloomberg, Kotak Institutional Equities (KIE) As of 5 th Jan 218 Confidential 3

Emerging Markets have benefited from rising global demand and weak USD World Economy has been expanding in 2 Other than Equities, even Gold was up 13% 59. 58. 57. 56. 55. 54. 53. 52. 51. 5. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov US Comp PMI Europe Comp PMI China Comp PMI 58 Above 5 - Expanding 54 53 Dec $/oz 1,4 1,35 1,3 1,25 1,2 1,15 1,1 1,5 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov 136.21 Dec 14. 12. 1. 98. 96. 94. 92. 9. 88. 86. 84. Jan US Dollar has remained under pressure despite decent US data Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 92 CY Return% 4. 35. 3. 25. 2. 15. 1. 5.. Weak dollar has helped fuel Emerging marker rally globally 36. 27.9 25.7 25.1 21.8 19.1 Hong Kong India US Dow Phillipines Korea Japan Source: Bloomberg Confidential 4

Equity Markets Trends Based on current run rate, Government is is expected to have to have 1% of 1% of GDP shortfall in in indirect tax tax collection Metal companies are are likely likely to restart to restart private private capex, capex, cement cement and Power and power might might follow follow 6 Rs. cr 24 875 78 9269 1469 Rs. bn 5 4 3 2 4525 1 CGST Excise - Petrol Custom Duties Total Indirect Tax FY 18BE Shortfall FY16 CL 18CL 19CL 2CL 6 5 Auto Sales have been rising at high pace reflecting strong consumer sentiment and demand 5.4 Intense pricing pressure in USA due to to customer consolidation is is leading to consolidation in in US US generic space space (eg. (eg. Teva) Teva) 16. Drug Price YoY% 12. YoY% 4 3 2 1-1 25.3 23.2 13.8 15.1 13.8 14.3 11.3 6.4 -.3 Jul- Aug- Sep- Oct- Nov- Commercial Vehicle Sale Passenger Vehicle Sales 8. 4.. -4. -8. Q3'11 Q2'12 Q1'13 Q4'13 Q3'14 Q2'15 Q1'16 Q4'16 Q3' Branded Generic Source: KIE, CLSA Confidential 5

L&T Dilip Buidcon NCC IRB Ashoka buildcon KNR Construc tions Hindusta n Construc tions Opportunity in Infrastructure Government had planned higher spend for Affordable Housing and has spent a large proportion already After L&T, 2 nd highest EPC player has a market cap of only 14k cr Rs bn 7 6 5 4 3 2 1 1 15 5 6 5 21, 18, 15, 12, 9, 6, 3, 187,493 13,823 8,612 7,455 4,673 4,444 4,381 FY15 FY16 FYRE FY18BE FY18 till Oct Government s Power for All initiative will pay out $25bn in capex with $5bn opportunity in Transmission by FY22 Government has announced 6.92 lk crore spend on roads under Bharatmala project by 222 USD Bn 14 12 1 8 6 4 2 12 5 25 Renewables Generation Sub Transmission and Distribution 5 Transmission 5 Energy Efficient Rs cr 8 7 6 5 4 3 2 1 692 535 157 Existing NH Projects By 219 Total 6 Source: Blooomberg, CLSA, Ministry of Power Confidential 6

Earnings and Valuation Liquidity and Hope of strong Earnings growth has led to slightly expensive valuations Mid Cap Index consensus earnings expectation has seen recent downgrade leading to widening premium over large cap MSCI India P/E Premium over MSCI EM is above long term average of 35-4% despite broad rally in EMs 3. 25. 2. 15. 1. 5.. Bloomberg Estimate 18. 15.4 33% Premium Large Cap Current 12M Forward PE 24. 16.3 Mid Cap 5 Year Average 12M Forward PE Mar 2 Apr 2 May 2 Jun 2 Jul 2 Aug 2 Sep 2 Oct 2 Nov 2 Dec 2 41.4% Jan 218 48% 44% 4% 36% 32% 28% 24% 2% 16% 12% 8% 4% % 54 53 52 51 5 49 Bloomberg Consensus FY18 Nifty earnings cut have slowed down recently 48 Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- 496 4. 35. 3. 25. 2. 15. 1. 5. - Infra looks attractive in terms of valuation, Consumers most expensive 18.5 18.3 35.5.5 21.3 16.7.2 Auto Banking Consumers Infra Pharma Tech Nifty 5 PE 219E Average Earnings Growth FY19E and FY2E Source: Bloomberg Actual/Expected >1.5 Better, Actual/Expected <.95 - Worse Confidential 7

Key Triggers Resolution of NPA & Earnings Positive Triggers Global Demand: GDP growth strong in US and Europe, exports oriented sectors can benefit Commodity Prices: Sustained high prices is expected to lead to high earnings growth in Steel/Oil sector and thus indirectly benefit Banks on NPA issues Resolution of NPA: Effective addressal and high recovery rates of NCLT cases will be positive for Banks Weaker Rupee: Benefit IT and Pharma Lower Corporate Tax: Talks of lowering tax rate in next Budget Government Capex: Government might increase spending irrespective of fiscal concerns ahead of General Election Risks Outflow from EMs: US tax reforms could again trigger capital flight back from EM to US Earnings: Consensus expected earnings growth for domestic equities is high at around 15-2%, any downgrade would make the valuations more expensive Geo-Political Risk: Uncertainty in Middle East, North Korea Monetary Policy: Faster than expected monetary tightening in Europe and US Economy Slowdown: Economy has been suffering for last 1 year and none of the economic indicators have shown signs of recovery yet Changes in Budget: Government could introduce LTCG tax on equity due to revenue shortfall post lower than expected GST collection Confidential 8

India Equities: Valuations & Strategy Maintain Neutral Stance For the month of December, Indian Equity markets continued its rally to make new life-time highs on the back of BJP s win in key states of Gujarat and Himachal Pradesh. With this gain, equity markets have locked in a gain of ~28% for calendar year 2. Inflows by mutual funds also continued post a small dip seen last month. At current levels of approx. 1,637 (1 th January, 218), Nifty is trading at a 1 year forward PE of 19X. In the current scenario, we continue to maintain a Neutral stance. Mutual Funds: As domestic liquidity continues to drive markets, we advise new investments in Mutual Funds to be deployed 25% in lumpsum and subsequent in tranches via SIPs/STPs. Recommended allocation within equity mutual funds is as under: 1% Large Cap allocation (Prefer Large Caps due to relatively Favorable Valuations) This allocation to Large caps can also be taken through Opportunistic Funds which currently have a bias towards Large cap For investors who want equity exposure but have low appetite for volatility, they can take equity exposure through Balanced Funds. Balanced funds have around 25% to 3% of their portfolio into Debt instruments which provides cushion to the portfolio return during market volatility. Source: EPS Estimates by KIE Confidential 9

Debt Market Update & Debt MF Strategy

Debt Market: Key Variables Indicators Policy Action For now, the rate cut cycle seems over Tone of the policy seemed neutral but with caution on inflation 1 Year G-Sec Benchmark Yield Near term upward pressure, can settle lower Liquidity Liquidity surplus has reduced significantly Expected to drift towards neutrality Inflation CPI inched up to 4.88% in Nov 2, higher than RBI forecast RBI increased CPI forecast by 1 bps to 4.3%-4.7% for 2HFY18 We expect CPI to remain firm at around 5% by Mar 218 INR INR to remain stable relative to remaining EM universe Expect mild depreciation towards 65.5 over 1 Year Broad range of 63-66 to hold G-Sec Supply Additional borrowing of INR 5, cr announced Higher borrowing could lead to slippage in fiscal deficit to the tune of upto 5 bps SDL supply for Jan - Mar quarter at INR 1.3 Lac Crs Key Risks Global monetary tightening Strengthening Crude Prices Impact of GST revenues and spending on Fiscal Deficit Higher inflation print Confidential 11

Yields have spiked over concerns on Fiscal Deficit, rising core inflation and falling Liquidity Amount in Rs. Bn % Yield % Yield Spread (bps) Spread (bps) Liquidity back to neutral level near quarter end 2, 1, 245 1/12 6/12 11/12 16/12 21/12 26/12 31/12 G Sec Spread over Repo near highest in last 1 Year over fiscal and inflation concerns 7.75 7.25 6.75 6.25 5.75 7.33 6. 133 14 12 1 8 6 4 2-1, Spread 1 Year G Sec Repo Rate Core inflation is inching up G Sec yields rose across the curve 6.% 5.% 4.% 3.% 2.% 1.% 4.88% 4.59% 7.6 7.2 6.8 6.4 6. 14 21 25 33 23 27 7.33 7.6 35 3 25 2 15 1 5.% Jan Feb Mar Apr CPI May Jun Jul Aug Sep Oct Nov Core Inflation 5.6 1Y 2Y 3Y 4Y 5Y 8Y 1Y Change Current G-Sec Yield 1M earlier G-Sec Yield Note: As of 4 th Jan 218, Source Bloomberg Confidential 12

Indian Bonds are still attractive to Foreign Investors however limits are almost utilized USD Million FIIs buying has slowed down despite Moody s upgrade since Utilization level is near 1%, CYTD $23bn inflow from FIIs 4,5 4, 3,5 3, 2,5 2, 1,5 1, 5-5 3,13 2,84 4,57 3,112 2,38 164 2,757 379 Apr May Jun Jul Aug Sep Oct Nov Dec -221 7 65 6 55 5 45 4 Crude prices have increased over events in Iran May Jun Jul Aug Sep Oct Nov Dec Jan 18 68.7 Indian currency has gained on global Dollar weakness FII Debt Utilization in GSecs and Corporate near 1% 69. 68. 1.% 8.% 95.% 94.9% 67. 66. 65. 64. 63.37 6.% 4.% 2.% 11.35% 63. Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan 18.% Dec 16 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Government Corporate SDL Note: As of 4 th Jan 218, Source Bloomberg Confidential 13

Debt Market Trends 8.8% 8.6% 8.4% 8.2% 8.% Perpetual Bond yields have become attractive 8.75% 8.7% 8.13% 8.12% 7.4 7.2 7. 6.8 6.6 CD and CP yields have spiked due to falling Liquidity leading to underperformance in Ultra Short Term Funds 1 Year CD 1 Year CP 7.8% Aug Dec 6.4 Jun Jul Aug Sep Oct Nov Dec SBI Perp HDFC Perp AAA Corporate Curve spreads over GSec have reduced significantly in last few months In 2, Credit Funds were the best performers, Gilt Funds were the worst performers with just 2% return Spread over 1 Year GSec 1. 9. 8. 7. 6. 5. 4. 3. 2. 1.. 25. 2. 15. 1. 5.. Jun Jul Aug Sep Oct Nov Dec 3 Year AAA 5 Year AAA SDL Credit RHS % 8. 7. 6. 5. 4. 3. 2. 1.. 7.45 5.87 4.94 3.25 2.14 Short Term Income Funds Credit Funds Dynamic Funds Gilt Funds Note: As of 31st Dec 2, Source Bloomberg, MFI Confidential 14

India Fixed Income: Strategy Substantial part of the portfolio should be deployed through a mix of high rated and credit accrual strategies. Exit from duration funds only for investors who have completed 3 years and can deploy with another 3 years view. Investment Focus: Passive Accrual-Oriented Debt funds High quality portfolios (~1% AAA / Sovereign) Portfolio is run on a passive accrual basis i.e buying a bond and holding it till maturity thereby earning from the accruing of interest Higher predictability of return, lower volatility & lower interest rate risk High Yield Credit-Oriented Funds Low volatility on account of maturity of portfolio between 3 5 years, attractive and stable accrual yields Experienced teams to carefully evaluate and tightly monitor high yielding debt instruments Short Term Bond Funds Actively managed to run a low avg. maturity of 2-3 years, attractive risk-reward Lower volatility and interest rate risk than Dynamic Bond Funds, better suited from a risk-adjusted basis in volatile markets Continue to recommend ultra short term relative to liquid funds (up to 3 Months) For short term parking of funds for a minimum of 6 months, Arbitrage funds preferred over ultra short term funds on back of better tax adjusted returns Source : AMCs, other Financial websites Confidential 15

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