Equity & Debt Strategy

Mid June - July’ 2017

Equity Market Update &

Equity MF Strategy

Confidential | 3

Nifty continue to rally although Mid/Small cap Stocks corrected

9,314

9,62118,126

17,510

16,000

16,500

17,000

17,500

18,000

18,500

19,000

9,100

9,200

9,300

9,400

9,500

9,600

9,700

02-May-17 08-May-17 14-May-17 20-May-17 26-May-17

NIFTY Index NSEMCAP Index

US Fed signals caution

on rate hikes

GST fixes rates, normal

monsoon expectation

10.2

33.4

-2.2

8.9

0.9

-4.2

9.3

4.31.8 2.3

11.4 9.0

-10.0

0.0

10.0

20.0

30.0

40.0

Feb 17 Mar 17 Apr 17 May 17

FII DII incl MF MF

10,361

6,864

1,242

0

10,000

20,000

India Dedicated GEM Others

Large Cap Outperformed Mid Cap this month Strong Buying by both FII and Mutual Funds

FII inflows through India Dedicated Funds which are more

long term in nature has been higher in the last 6 months

Rs. cr

Source: Bloomberg, AMFI, KIE,EPFR. As of 31st May 2017YoY% unless specified

‘000 cr

Share of AUM from B15 increasing , Equity share of AUM

for B15 at 53% vs 29% for T15

% AUM86.35% 85.28%

10.84% 11.31%2.80% 3.61%

0%

20%

40%

60%

80%

100%

Mar-14 Mar-17

Top 15 Next 85 Cities Beyond Top 100

Confidential | 4

232

50

174

138 vs 185 Exp

2.82.6

2.5

2.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0

50

100

150

200

250

Feb 17 Mar 17 Apr 17 May 17

US Nonfarm Payrolls US Wage Growth

European Economy doing well, reflation peaking

USA employment data disappoints , Dollar Index falls ~3%Europe Economy getting stronger ,lower inflation reading

may keep ECB rates low

US inflation has started to reverse from peak level

Source: Bloomberg

%

Chinese economy has been stabilizing with de-

acceleration in Capital Outflows and Shadow Banking

2.0

1.51.9

1.4

56.056.4 56.8 56.8

0.0

0.5

1.0

1.5

2.0

2.5

50.0

52.0

54.0

56.0

58.0

Feb 17 Mar 17 Apr 17 May 17

Europe Inflation RHS Europe Comp PMI

Above 50 - Expanding

Source: BloombergYoY% unless specified

55%

22%

-100

-80

-60

-40

-20

0

20

0%

10%

20%

30%

40%

50%

60%

70%

31-Aug-16 31-Oct-16 31-Dec-16 28-Feb-17 30-Apr-17

Shadow Banking Growth Capital Flow $Bn RHS

2.1 1.9 1.7 1.7

7.8 7.6

6.4 6.4

0.0

2.0

4.0

6.0

8.0

10.0

Feb 17 Mar 17 Apr 17 May 17

US Inflation China Factory Gate Inflation

Confidential | 5

Manufacturing demand weak as firms dip their inventory before GST

-5.2

-1.9 -1.0

12.0

16.714.8

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

Feb 17 Mar 17 Apr 17

Credit Industry Credit Personal

9.010.0

14.7

-2.9 -0.8-2.8

-0.2

1.4

-5.0

0.0

5.0

10.0

15.0

20.0

Feb 17 Mar 17 Apr 17

Passenger Vehicle Sales Consumer Durables Fuel Retail

0.6

5.3

2.5

-15.8

-6.8

-3.7

-15.8

-5.9

-16.0

1.4 1.2

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

Feb 17 Mar 17 Apr 17

Core Infra Cement Production Bitumen (Road) IIP Manufacturing

Credit – Demand still low Consumption – Recovers slightly this month

Manufacturing – Still weak Services PMI recovers in May

Source: Bloomberg, KIEYoY% unless specified

NA

52.351.3

52.552.5 52.551.651.5

50.2

52.2

45.847.2

45.2

40.0

42.0

44.0

46.0

48.0

50.0

52.0

54.0

Mar 17 Apr 17 May 17

India PMI India PMI - Manufacturing

India PMI - Services PMI -Stocks of Finished Goods

NA

Confidential | 6

Rural Economy expected to do well

Number of households working under MNREGA has

increased due to increased Govt. expenditure

Farm Growth is expected to be 4.1% because of good

monsoons

Source SBI Ecoflash, Nomura, BSE , Economic SurveyYoY% unless specified

Rural Consumption indicators have started to recover

8,300,000

16,700,000

Oct-16 Feb-17

1.5

4.2

-0.2

1.2

4.1

-0.50

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

2013FY 2014FY 2015FY 2016FY 2017FY

% %

-5.9

-22

-7.4

0 0.3

7.3

-13.3

7.7 5.5 7.5

24.519.3

-30

-20

-10

0

10

20

30

Nov 16 Dec 16 Jan 17 Feb 17 Mar 17 Apr 17

2W Sales Tractor Sales

Rural wage growth has been strong

8.1

3.63.00

4.00

5.00

6.00

7.00

8.00

9.00

Sep 16 Oct 16 Nov 16 Dec 16 Jan 17 Feb 17 Mar 17 Apr 17 May 17

Rural Agri Wages Rural Unemployment

Confidential | 7

Nifty @9650 Current 12M Forward PE 10 Year Historic Forward

Bloomberg P/E

ValuationBloomberg Consensus

KIE Estimate

Large Cap – Nifty 17.7 18.9 15Nifty FY 17-18 Earnings

growth22.7% 9.5%

Mid Cap - Nifty Mid 100 19.40 - 13-14

Large vs Mid Premium -8.8% - ~10%

Earnings and Valuation –Liquidity and Hope of strong Earnings growth in FY17-18 has led to slightly expensive valuations

Nifty trading at 18.9x one year forward earningsIndia P/E Premium over MSCI EM is still at 41% near

average as other EMs have also rallied in CY17

Nifty Q4 EPS grew by 23.2%* YoY, Tata Motor & Tata Steel

were above expectation while Pharma disappointedBanking and Automobile sector to lead Earnings growth in

coming next 2 Fiscal Years

Source: Bloomberg, KIE Estimates Outperformed if PAT>1.05x Expected, Underperformed if PAT<0.95 of expectedYoY% unless specified, *9.3% ex Tata Steel and IOCL.

18%17%

15%16%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

India Hong Kong Phillipines South Korea

13

18

16

Outperformed Underperformed As Expected

Sector Adj. mcap. Earnings growth (%) PER (X)

Free Float Basis (US$ bn) 2017E 2018E 2019E 2018E 2019E

Automobiles 64.5 (4.6) 17.2 26.7 21.7 17.1

Banking 194.7 16.8 19.9 36.8 22.4 16.4

Consumers 62.3 6.9 13.0 13.6 39.9 35.1

Energy 55.1 43.7 (10.1) 12.3 12.4 11.0

Technology 67.7 9.3 (1.3) 8.9 17.1 15.7

Nifty 50 19.5 7.0 20.7 18.9 15.6

Nifty 50 (ex Energy) 12.7 13.2 23.1 20.7 16.8

CY17 Return

Confidential | 8

Key Triggers – GST Implementation and Monsoon

• Global Economic data : World economy improving. Expectation of fiscal stimulus from Republican Government

• Lower Domestic Interest rates: Many Banks have cut their MCLR sharply which should help in reviving credit demand

• Resolution of NPA: Effective addressal by government of NPA issue in Indian Banks

• Monsoons: Skymet has forecasted normal monsoons which would be beneficial to the rural economy

Positive Triggers

• US Policies: Revival of Trump/Reflation trade could lead to EM outflows again

• Earnings: Consensus expected earnings growth for domestic equities is high at around 20%, any downgrade would make the valuations more expensive

• GST implementation: GST implementation could be disruptive in short term especially for small players

• Geo-Political Risk: Political uncertainty in UK, Germany, Netherland

Risks

Confidential | 9

India Equities: Valuations & Strategy – Maintain Neutral Stance

At current levels of approx. 9650 (9th June, 2017), Sensex is trading at a 1 year forward PE of 18.9X. Also the ratio of potential upside to downside is slightly biased towards downside at current valuations.

Risk-Reward Scenario based on earnings growth & valuations:

New Deployments:

Many investors had been sitting on the side-lineswaiting for triggers like state election results as aconsequence of which they could not be a part ofthe recent 500 plus points rally post the results.Expectations of good monsoons and ampleliquidity further helped markets to reach new lifetime highs. In the June Monetary Policy, thecentral bank maintained its neutral stancehowever without a unanimous decision. Eventsmay come and go but the best strategy is toremain invested and choose the staggered routefor additional investments.

- Mutual Funds: Invest 25% immediately andsubsequent in tranches via SIPs/STPs

On a risk-reward basis we continue to maintain Neutral stance

• Recommended allocation within equity mutual funds is as under:

• 100% 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 20% to 30% allocated to Debt which provides cushion to the portfolio returns during

market volatility.

Source: EPS Estimates by KIE

Nifty @ 9650 Fwd PE(X)Fwd EPS Estimate

Estimate Target

Nifty Level% Upside / Downside

1 Year Upside 18 590 Q1-FY19 10,620 10.05%

Downside 16 511 Q4-FY19 8,176 -15.27%

Debt Market Update &

Debt MF Strategy

Confidential | 11

Indicators

Policy Action

• RBI maintain status quo on rates

• The commentary from MPC members was relatively dovish

• Govt. attempting to provide inputs to MPC before every policy

Inflation

• CPI came at all time low of 2.99% in April 2017

• RBI expects 2.0-3.5% in H1 and 3.5-4.5% in H2

10 Year G-Sec Benchmark Yield

• 10 yr yield likely to remain in range

• New 10 year benchmark is trading 12-14 bps lower than

its issuance at 6.79

Liquidity

• Liquidity stands in surplus at ~Rs 3.5 trn plus

• RBI acting more liberal in terms of its stance on liquidity

INR

• Stable around 64.50

• Likely to remain in a range

Key Risks

• US policies; Aggressive Fed hikes

• Monsoon and its impact on food prices

• Strengthening of US Dollar

• Global commodity price escalation including crude

G-Sec Supply

• The gross G-Sec supply to be Rs. 5.8 trn

• SDL issuance of ~4 trn + expected

Debt Market: Key Variables

Confidential | 12Source: Bloomberg

As of 7th June 2017

Rate cut expectations come back after benign inflation

-1

-19-23 -23

-11

-25

-36

6.63

-40

-30

-20

-10

0

6.00

6.40

6.80

7.20

7.60

1Y 2Y 3Y 4Y 5Y 8Y 10Y

Sp

read

(b

ps

)

% Y

ield

Bonds rallied post inflation data, new benchmark trading 10 bps lower

Change Current G-Sec Yield 1M earlier G-Sec Yield

2.99%

4.14%

Jun16

Jul 16 Aug16

Sep16

Oct16

Nov16

Dec16

Jan17

Feb17

Mar17

Apr17

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%Inflation fell below expectation but core remains

sticky

CPI

Core Inflation

3,594

0

1,000

2,000

3,000

4,000

5,000

08 10 12 14 16 18 20 22 24 26 28 30 01 03 05 07

Am

ou

nt

in R

s. B

n

Excess liquidity to remain for now

38

6.63

6.25

0

10

20

30

40

50

60

70

80

6.00

6.50

7.00

7.50

8.00

Spre

ad (

bp

s)

% Y

ield

G Sec Spread over Repo below average

Spread 10 Year G Sec Repo Rate

* Avg Spread over Repo in Falling rate regime – 61 bpsAverage Spread over Repo in Rising rate regime – 71 bps

Confidential | 13

Strong macros and low inflation driving FII Flows

68.56

64.51

Jun16

Jul 16 Aug16

Sep16

Oct16

Nov16

Dec16

Jan17

Feb17

Mar17

Apr17

May17

64.0064.5065.0065.5066.0066.5067.0067.5068.0068.5069.00

INR remains stable around strong 64.5 level

Source: Bloomberg , Crisil Rating

As of 31st May 2017

4.76

1.29

5.62

4.46

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

%

Widening Real Return in India vs US driving flows

Inflation Differential Yield Differential

1.0

1.51.7

Q32013

Q42013

Q12014

Q22014

Q32014

Q42014

Q12015

Q22015

Q32015

Q42015

Q12016

Q22016

Q32016

Q42016

Q12017

Q22017

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Upgrade/Downgrade ratio have improved significantly compared to 2013

3,138

Oct 16 Nov 16 Dec 16 Jan 17 Feb 17 Mar 17 Apr 17 May 17

-4,000

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000

US

D M

illi

on

Strong FIIs buying continue

Confidential | 14

India Fixed Income: Strategy

Substantial part of the portfolio should to be played 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 (~100% 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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