alpha edge - january 2015

lpha Edge

www.citadelle.in

Ques�ons

Insight

Analysis

Ac�on

lpha Edge“Not so fast !”

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Not so fast !

3January 2015January 2015

ForewordDear Investor,

At the outset let me wish you and your family a Happy New Year !

We have every reason to begin this year on a happy note. Well! Why not? It’s almost after half a decade; we as a nation seem to want to shake off the slumber in our economic lives. One can almost feel the optimism in the air, with all our portfolios swelling with pride thanks to the Modi-fied market mood.

Warm Regards,

India Strategy | January 1st, 2015

A V Srikanth

We will all need to maneuver our way around the challenges ahead of us – A beginning environment of higher valuations, almost flat yield curve at higher levels of interest rates that signal uncertain expectations of growth by the savvier bond markets, slowing global growth from key economic blocs – Eurozone, Japan and China, which in interlinked ways reflect and affect our exports, a strengthening dollar which reflects a potential risk to emerging markets, even if it innocently originates from U.S economy’s strength.

As we rejoice in the glow of the recent up-move, we now step into 2015, into what may well be interesting times. Wait a minute! Are we not in a bull market…? The greatest ever..? A bull market that makes all of us look smart and every portfolio like an ATM? Well… Last year at this time, the mood of most investors was neutral to mildly positive, and the year turned out to be wildly positive. If one knows Mr. Market’s nature to constantly surprise, we can almost guess as to what may follow as we step into 2015 with unbridled optimism. Atleast a pause..? We at Citadelle believe that it can be a tough, but rewarding 2015. A year where returns will be hard fought for and accrue by deft asset allocation calls coupled with superior security selection moves. 2015 will be a year that shall separate an Advisor from a Relationship Manager and we are prepared for this.

It is in this environment that we believe 2015’s Equity returns can mostly come from EPS growth and not P/E re-rating. We feel that in 2015, Flexible Bond funds will out-perform other debt options, as the room to cut rates isn’t so much that it isn’t already discounted. The time for Gold may once come again at some point during the year and real estate may be in for a long pause. All in all, it is a year where caution is likely to make you happy. Read on for how you can get the best out of 2015 and be ahead of the game!

nothing, atleast the markets have to be very cheap to begin with. The recent run up had none of these hallmarks. This worries us on account of universally high expectations going into 2015 after a pleasant surprise of 2014. We believe 2015 will be the year of moderation and specifics.

If you hear a subtle caution in our tone, you are right and here are our reasons for questioning the foundations of one’s hyper bullish expectations from 2015. For those in the game long enough, one knows that a bull market needs low interest rates and not lower interest rates.. a yield curve that signals greater future economic expectation by its upward sloping nature and not a flat or inverted on.. a credible turn around after bottoming out of an economic cycle and not a continued suspicion of it.. a global environment which is conducive and not one which inspires ambivalence. If

Alpha Edge | Not so fast !


16-May-2014, 7203.00

10-Jul-2014, 7567.75

26-Sep-2014, 7968.85

28-Nov-2014, 8588.25

5000.00

5500.00

6000.00

6500.00

7000.00

7500.00

8000.00

8500.00

9000.00Ja

n/14

Jan/

14

Feb/

14

Mar

/14

Mar

/14

Apr/

14

May

/14

May

/14

Jun/

14

Jul/1

4

Jul/1

4

Aug/

14

Sep/

14

Oct

/14

Oct

/14

Nov

/14

Dec/

14

Nifty Index

Source: nseindia.com

Time Line graph of Nifty

16 May – The results of elections 2014 were declared. UPA was defeated, winning 61 seats compared to 218 the last time. NDA's seat count increased by 198 to 335 in this elections, compared to 137 in last elections.

10 July - 2014 Union budget of India presented in the Parliament

26 September - Standard and Poor's raised the outlook for India's "BBB-minus" rating to "stable" from "negative," saying the country's government mandate and improved political setting offered a conducive environment for reforms.


28 November - OPEC decides not to cut its oil production output amid falling oil prices. A game changing event as history shall remember



Challenges of 2014

Domestic : At the dawn of 2014, India was plagued with sluggish economic growth, spiraling inflation, twin deficit problem, a sharply falling Rupee, a paralyzed government and a deteriorating moral fabric caused by corruption seeping into the core of our society.

Global : Federal Reserve announcement to taper quantitative easing in its December 2013 meeting has left the markets much confused on its further course of action. Market participants expected the Fed to scale back its entire USD 85bn in purchases by the end of 2014, albeit in a calibrated manner.

What has happened / How things turnaround

The month of May was marked by a triumphant victory at the Centre. After a gap of thirty years, a national party, on its own, recorded a clear mandate and formed the government. The BJP’s very successful campaign was based on a key agenda of development coupled with tackling jobs, growth, inflation and corruption.

The NDA government has solemnly begun with the Reforms

Labour reforms: The government has proposed various amendments to the Apprenticeship Act, Factories Act and Labour Laws. All of these are aimed at easing the hurdles employers face and reducing some of the onerous provisions within them, especially those relating to criminal prosecution for non-violation, and reducing the power with labour inspectors. We believe the previous government severely disappointed on amending labour laws.

Railway Budget: The government hiked passenger fares by 14.2% and freight rates by 6.5%. Suburban was rolled back partially, but it contributes only 2% to total railway revenues. One of the key highlights was the intention to attract private investors – both domestic and foreign - through a Public Private Partnership (PPP) model. It also promised to open up foreign direct investment (FDI) in railway projects. It gave a go-ahead to the much awaited bullet trains and promised more trains to certain

destinations. Better railway facilities were also on the cards at major tourist destinations.

Union Budget: Within constraints, the new Finance Minister was able to deliver a direction to the economic policy. Budget support for NHAI was increased by 25%, with an aim to build 8500kms of roads in FY15.

Guidelines for REITs were clarified, and the same concept has been extended to Infrastructure assets too. CRR and SLR have been waived for long-term funds raised by banks for lending to the infrastructure sector.

Subsidies are targeted to reduce from 2.3% of GDP to 2%. FM hinted at coming out with a new urea policy as the current nutrient-based policy is causing distortions in use of fertilizers and degrading soil quality. Also, a comprehensive overhauling of the subsidy regime is in the offing; Direct Benefit Transfer for targeted subsidy to be the main focus.

Controlling Inflation: The government imposed a restriction of exports of some essential farm products and also cracked down on hoarding for controlling rising food prices. The Centre took the decision on July 2, 2014 of including onions and potatoes under the Essential Commodities Act, 1955, to let states set stock holding limits on these food items so that their prices don’t cross a certain level.

Standard & Poor’s rated outlook as “stable” from “negative”: Standard and Poor's raised the outlook for India's "BBB-minus" rating to "stable" from "negative," saying the country's government mandate and improved political setting offered a conducive environment for reforms.

S&P had cut India's outlook to "negative" in April 2012. India is now rated at the lowest investment grade with a "stable" outlook by all three major global credit agencies.

S&P's upgrade of India outlook should augur well for foreign inflows and borrowing cost will also come down for companies.



Post May elections, FII net inflow has been ~60K Crs

Source: Bloomberg

India has been the favorites amongst the Emerging markets and has seen a FII net inflows of roughly Rs 60,000 Crs after the May elections.

Asset Class performance for 2014

Asset Class Returns For 2014

Source: Bloomberg

Equity has been the best performer for the calendar year 2014 with returns of 31.4% followed by long term debt performance of 16.5%. Gold has been the worst performer with returns of 1.9%.

FII Flows in 2014

Source: Bloomberg

Flows have continued to be buoyant in Equities and Debt markets in the Calendar year 2014. Equities so Net Inflow of Rs 97,069 Crs whereas Debt market has seen whooping net inflow of Rs 159,199 Crs.

Sector Returns

Source: Bloomberg

Consumer Durables, Banks and Auto have been outperformers for CY 2014. Metal, Realty and Oil & Gas have been the laggards during the same period

39 47 3771

-53

83133

-3

128 113 973

-6

49

12

5

46

42

35

-51

160

-100

-50

0

50

100

150

200

250

300

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

FII F

low

s (in

`000

Crs

)

Equity Debt

-20,000020,00040,00060,00080,000100,000120,000

500055006000650070007500800085009000

Jan-

14

Feb-

14

Mar

-14

Apr-

14

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec-

14

Post May elections, FII net inflow has been ~60K Crs

YTD Cumulative FII Net Inflows (INR Crs, RHS) Nifty

31.4%

16.5%

9.2%

1.9%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Equity 10 yr Tresuries Cash Gold

Asset Class Returns For 2014

88

12161718

2330

3947

5052

556566

69

0 20 40 60 80

S&P BSE METAL IndexS&P BSE Realty Index

S&P BSE OIL & GAS IndexS&P BSE TECk Index

S&P BSE ITS&P BSE FMCG

S&P BSE Power IndexS&P BSE SENSEX

S&P BSE PSUS&P BSE Health Care

S&P BSE Capital GoodsS&P BSE AUTO Index

S&P BSE Mid-CapS&P BSE BANKEX

S&P BSE Consumer DurablesS&P BSE Small-Cap

Sector Returns for 2014 (%)



Challenges of 2015

The three key concerns for India are:

v Valuations already pricing in the reforms and growth story of the coming year;

v The growth cycle remains hesitant; and

v Tumbling crude price is perceived as a boon for India, but are the benefits exaggerated?

Valuations already pricing in the reforms and growth story of the coming year:

Source: Bloomberg

Source: Bloomberg

Nifty is up by 31.4% on a CYTD basis on reforms expected by the NDA led government and the growth story anticipated resulting from the Economic recovery and the reforms. The earnings are yet to pick up momentum the valuations has soared up to 21.0 x from 18.7x at the beginning of the CY14 on a TTM basis due to superlative

performance from Nifty.

The growth cycle remains hesitant:

Source: Bloomberg

Though the earnings cycle seemed to have bottomed out, the momentum is yet to pick up. Revenues have been passable for last couple of quarters, however ability to utilize surplus capacity coupled with expected significant margin improvement through improvement in working capital management would augur well for earnings improvement. Additionally, expected easing of interest rates over 12 to 18 months would also bring down interest burden further adding to margins.

-10%-5%0%5%10%15%20%25%30%35%

1012141618202224262830

Mar

/07

Sep/

07

Mar

/08

Sep/

08

Mar

/09

Sep/

09

Mar

/10

Sep/

10

Mar

/11

Sep/

11

Mar

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Sep/

12

Mar

/13

Sep/

13

Mar

/14

Sep/

14

EPS YoY (%) Nifty Index PE

28.25

10.68

21.01

19.1

0

5

10

15

20

25

30

Dec-

04Ap

r-05

Aug-

05De

c-05

Apr-

06Au

g-06

Dec-

06Ap

r-07

Aug-

07De

c-07

Apr-

08Au

g-08

Dec-

08Ap

r-09

Aug-

09De

c-09

Apr-

10Au

g-10

Dec-

10Ap

r-11

Aug-

11De

c-11

Apr-

12Au

g-12

Dec-

12Ap

r-13

Aug-

13De

c-13

Apr-

14Au

g-14

Dec-

14

Nifty PE Long Term Avg (10 yrs)

30%

-8%

12%

-15%-10%

-5%0%5%

10%15%20%25%30%35%

Mar

/07

Sep/

07

Mar

/08

Sep/

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Mar

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Sep/

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EPS YoY (%)



Tumbling crude price is perceived as a boon for India, but are the benefits exaggerated? :

The line of argument is familiar - Lower crude prices hasten disinflationary pressure, lower imports, reduce oil subsidy, lower fiscal deficit and rates, thereby boosting earnings and ratings. The underlying assumption behind this argument is the inverse correlation between commodity prices and India’s GDP growth and earnings.

Positive Correlation:

India Real GDP vs Crude (% YoY):

Source: Bloomberg

India Real ex-agri GDP vs Crude (% YoY)

Source: Bloomberg

The correlation between crude price (YoY) and India’s real GDP growth and corporate earnings is predominantly positive, implying that growths

in GDP and corporate profits rise/fall with rising/declining crude prices.

Operating Profit of no-finance cos vs Crude (YoY %)

Source: Bloomberg

Possible explanations are:

Ø Stronger USD is generally accompanied by weakening in crude, other commodity prices and EM currencies,

Ø India growth cycle has converged with global cycle, specifically Europe. Hence, cost advantage from declining commodity prices is neutralized by slower growth in India

-60-40-20020406080100

0

2

4

6

8

10

12

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

Real GDP vs Brent (%YoY)

Real GDP Brent (%YoY), rhs

-60-40-20020406080100

0

2

4

6

8

10

12

14

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

Real GDP ex-agri vs Brent (%YoY)

Real GDP ex- agri Brent (%YoY), rhs

-100

-50

0

50

100

-100

1020304050

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

Operating Profit of no-finance cos vs Crude (YoY %)

Operating Profit YoY(%) Brent

Ø Recent declines triggered by growth concerns in Europe, Japan and China; Causality runs from the growth to commodity prices as higher the growth more the demand of raw materials such as commodities, which in turn escalate the commodity prices and vice versa

Ø Sharp decline in demand/supply below 100%,



Global Macro

Global Economy – Inclusive Growth… A wait for Godot

Despite setbacks, an uneven global recovery continues. Largely due to weaker-than-expected global activity in the first half of 2014, the growth forecast for the world economy has been revised downward to 3.3 percent for this year by IMF.

Oil Price – Free fall continues

Oil prices have been on a down trend since June 2014. From USD 110 per barrel levels in June 2014 to sub USD 60 per barrel levels, reflecting a weak demand and an over-supply of oil on the world market, which has driven oil prices lower. However it is important to note that in the current scenario oil price weakness is a more a function of excess supply, rather than a problem with demand. OPEC in their November meet have decided on not to cut production. Oil prices declined further by 10% following the decision. Large oil importers are getting a sizable boost to terms of trade, a welcome easing of inflationary pressure and an opportunity to liberalize prices and cut subsidies.

Low oil prices would also help reduce energy subsidy spending in a number of oil importing countries. Many countries are using this as an opportunity to liberalize prices and reduce the subsidy bill with only limited price adjustments:

India and Malaysia have already cut fuel subsidies and Turkey has raised electricity and gas tariffs, while Indonesia is expected to hike fuel prices soon.

Euro Area – Growth Slows, ECB Keeps Rates on Hold

The Eurozone economy advanced 0.2 percent in the third quarter of 2014, up from a 0.1 percent expansion

reported from April to June. Preliminary figures came in better than expected, as GDP accelerated in France and Germany avoided recession. But the main disappointment was the overall muted pace of the recovery and the continued malaise in Italy, where GDP has declined in 12 out of the last 13 quarters. Eurozone Manufacturing PMI slowed down to 50.1 in November of 2014, down from a flash estimate of 50.4 and 50.6 in the previous month. Factory activity shrank in Germany, France and Italy, offsetting growth in Spain, Ireland and the Netherlands.

The European Central Bank left its benchmark interest rate unchanged at a record low of 0.05 percent. Policymakers also said further stimulus measures were being prepared for use, if needed.

The risks surrounding the economic outlook for the Euro area continue to be on the downside. In particular, the weakening in the Euro area’s growth momentum, alongside heightened geopolitical risks, could dampen confidence and, in particular, private investment. In addition, insufficient progress in structural reforms in Euro area countries constitutes a key downward risk to the economic outlook.

China cuts rates

The People's Bank of China decided to cut the benchmark interest rate by 40 bps to 5.60 percent on November 21st.

China’s central bank succumbed to political and market pressure and cut interest rates for the first time in more than two years.



Domestic Macro

GDP growth seems to have a gradual recovery

Source: Bloomberg

Cumulative IIP of ~1% in the last two years has created a favorable base for future growth. Industrial growth seems to be back on track. Focus of the government on industrial revival may lead to faster recovery in the coming years.

IIP on recovery path

Source: Bloomberg

Latest trade and BoP data point to continued comfort on the external front. The CAD / GDP ratio has corrected sharply to 1.7% from a high of 4.7% in FY13. The Government has also indicated its resolve to walk the fiscal tight rope by limiting deficit to 4.1% of GDP in FY15.

Twin deficit down to manageable levels

Source: Bloomberg

9.3

6.7

8.6 8.9

6.7

4.5 4.75.6

6.5

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E

GDP growth (%)

7 yr Avg.: 7.1%

2.5 2.7

-2.8-2.0

-0.7 -0.6

3.5

-1.8

2.7

0.1

-0.5

3.42.8

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Sep-

11

Dec-

11

Mar

-12

Jun-

12

Sep-

12

Dec-

12

Mar

-13

Jun-

13

Sep-

13

Dec-

13

Mar

-14

Jun-

14

Sep-

14

IIP growth (%)

3.3

2.5

66.5

4.9

5.9

4.94.6

4.1

11.3

2.32.8 2.6

4.24.7

1.7 1.6

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E

Fiscal Deficit CAD

India’s current growth is well below its long term average of 7%. Q2 FY15 growth rose to 5.3%. This means a sharp acceleration from the below 5% growth seen for nearly eight quarters. Hence, growth seems to have bottomed out.



Global Macro

OilHistory suggests lower oil prices tend to boost global growth and reduce global inflation.

A supply-driven decline in oil prices is likely to be a positive for the global economy in aggregate. A demand-driven decline is likely to be a sign of a deeper disorder.

The violence of the oil price decline in 2014 has been striking: a drop of more than 45% from a localized peak in June of USD116 to around USD62 now. What does this mean for the global economy? Is it a mid-1980s shot in the arm or is it, instead, a late-2008 sign of financial collapse?

The recent decline in oil prices appears to contain elements of both, yet real-time information is insufficient to determine the relative weights.

After all, if the reasons behind the oil price decline are ambiguous, the consequences for the global economy will remain uncertain for months to come. Under those circumstances, crude hope will be trumped by complicated reality.

Still, it’s possible that “good deflation” might drive out “bad deflation”. Big declines in oil and other commodity prices will boost household and corporate real incomes in commodity-consuming parts of the world; we might be on the verge of witnessing a combination of both higher growth and lower inflation and, in some cases, outright deflation.

That was, after all, the experience of many developed-world nations in the second half of the 1980s.

US Interest RatesMoreover, lower oil prices are typically associated with periods of sustained monetary easing, starting with the Federal Reserve in Washington. Even though a period of lower inflation could eventually persuade the Fed to delay the widely expected monetary tightening in 2015, there simply isn’t room for the rate cuts seen in the 1980s and the 1990s.

US Dollar IndexThe US Dollar Index (USDX) is an index (or measure) of the value of the United States dollar relative to a basket

of foreign currencies.

It is a weighted geometric mean of the dollar's value relative to other select currencies:

Source: Bloomberg, Citadelle

The bulk of the calculation comes from the Euro, which makes up 57.6% of the index, followed by the Japanese yen at a 13.6% weight, and the British pound sterling, which comprises 11.9%.

Together, these three currencies represent 83.1% of the index and explain why the main dollar index has been performing as well as it has this year.

As Mr. Draghi is on a clear path to provide as much monetary stimulus as he can to weaken the currency, increase inflation expectations, decrease deflationary expectations, and also keep the European economy on life support.

While, The Bank of Japan has kept its record stimulus unchanged at the conclusion of a two-day meeting, maintaining its pledge to increase the monetary base at an annual pace of 60 trillion yen ($570 billion) to 70 trillion yen.

With both these currencies taking a downward path and improvement in the US current account deficit; deleveraging in the private sector; a boom in domestic energy production; improving growth prospects at a time when the forecasts of other regions are being revised down are making a strong case for dollar strengthening in 2015.

Euro (EUR), 57.60%

Japanese yen (JPY), 13.60%

Pound sterling (GBP),

11.90%

Canadian dollar (CAD),

9.10%

Swedish krona (SEK),

4.20%Swiss franc

(CHF), 3.60%

What we perceive can happen in 2015?



Domestic Macro

The consensus view of lower commodity prices being a boon for India is perhaps directionally appropriate, but overstates the advantages. The absolute impact on the economy is likely to be only neutral to slightly positive. We believe there are three areas that are impacted:

Ø Marginal impact on the Balance of Payments (BoP): There has been a significant reduction in oil prices and capital inflows have slowed too. But while lower oil prices would definitely lower the import bill, given that weaker global demand is a driver of cheaper oil, India's exports are likely to get hurt as well (and they are). Further, as surpluses in capital exporting economies (like oil producers) are eroded, capital flows could get constrained as well, as those economies have less capital to invest abroad.

The impact on BoP surplus, therefore, could be marginal, and stay at US$40-45 bn.

Ø Impact on the fiscal deficit: The FY15 budgeted amount for fuel subsidies (Rs634 bn, 0.5% of GDP), and that for fertilizer subsidies (Rs. 730bn, 0.6% of GDP) may not change much for FY15, as Rs. 350bn of the oil subsidy is already spent (a carryover from last year), but should help the fiscal deficit assumptions for FY16E

Ø Low Impact on inflation: Many believe the nearly 45% fall in crude would significantly alter the course of inflation in India. However, imported commodities are an insignificant part of CPI inflation—petrol and diesel together have a 2% weight in the index and the government's raising of excise duties to support its own budget reduces the pass through to consumer prices. Moreover, LPG and Kerosene, which have higher weights, are still subsidised, so the fall in crude will not directly impact retail prices. Lastly, second-round effects of diesel's decline may be limited; freight operators had not raised freight rates in the last three years despite a nearly 50% rise in diesel costs, and of late they are seeing some improvement in volumes.



The BJP led NDA government has now got strong political mandate winning 282 seats, the largest electoral victory to a single part in last thirty years. The new government has come out with an agenda for strong governance and economic reforms enabling a host of changes like, Diesel Deregulation, FDI in Defence & Railways, FDI in Insurance, Coal block auctions and Land acquisition bill to name a few. Further action on Online project Clearance and pushing for GST into a law are on its agenda. NDA has given a clear road map for reforms and its inclination toward them. The commitment would, however, need support from other political counterparts as well. Having said that, in our view a pro-business government coupled with decisive leadership will accelerate the reforms and growth process.

The impact of Reforms:

Banks: The sector should eventually benefit from investment reforms through pick-up in credit growth.

The mounting NPLs in the sector should be addressed by the overall economic recovery, lower interest rates and power sector reforms. Although, it remains to be seen how the government, the regulator and the banks address the problems in certain sectors.

Consumers – Staples and Discretionary: Fiscal consolidation measures such as minor increase in MSPs and a possible pull-back from MG-NREGS to restrict it to 200 districts in the country and a small but consistent increase in prices of LPG and power may reduce disposable income elsewhere and may have a moderately negative impact on consumption over the next 1-2 years.

But the sharp decline in crude oil prices and consequent reduction in retails prices of diesel and gasoline may moderate the impact on demand for automobiles. Also, a decline in interest rates over the next couple of years may reduce the total cost of ownership of vehicles and spur demand.

Reforms: Will be the Key Driver

The BJP led NDA government has now got strong political mandate winning 282 seats, the largest electoral victory to a single part in last thirty years. The new government has come out with an agenda for strong governance and economic reforms enabling a host of changes like, Diesel Deregulation, FDI in Defence & Railways, FDI in Insurance, Coal block auctions and Land acquisition bill to name a few. Further action on Online project Clearance and pushing for GST into a law are on its agenda. NDA has given a clear road map for reforms and its inclination toward them. The commitment would, however, need support from other political counterparts as well. Having said that, in our view a pro-business government coupled with decisive leadership will accelerate the reforms and growth process.

•Diesel Deregulation •Easer FDI norms for Defense/ Rail/ Construction

•Ease of doing business (Self attestation, Labourlaw in some states

•Dual use items having military as well as civilian applications deregulated.

•Abolition of eGoMsand GoMs

•Faster decision making & Effective bureaucracy.

What has happened?

•FDI in Insurance • Land Acquisition amendment

• Coal Block Auctions • Coal Output enhancement plan

• Direct Benefit Transfer.

• Ease in environmental approval

• Work on Smart Cities development

• Plugging subsidies

What is hapenning? • Time line for all clearances along with online clearance

• Multiple returns for different departments to be replaced by one simplified return.

• Divestment of bleeding PSUs

• GST - Ordinance to a Law

What is likely to happen?

Reforms: Will be the Key Driver

We would like to highlight the impact of the reforms on various sectors:



Energy Companies:

Energy sector will be a major beneficiary of fuel reforms. The government may finally be in a position to reduce its control over pricing in the energy sector, which may restore the financial health of the companies and enable more investment in the upstream and downstream energy sectors. Lower crude prices will accelerate the process of deregulation in the sector.

The steep fall in the prices of crude at the end of the CY2014 will result in normal marketing margins for the downstream companies and a reduction in the absolute quantum of subsidies that are borne by the upstream companies.

Industrials and Infrastructure: We expect the industrials and infrastructure sectors to benefit from investment reforms in the medium term. However, fresh investment may be 2-4 quarters away and is contingent on the government fixing some of the issues that have plagued

investment in the past 3-4 years. We expect a gradual recovery and are encouraged by the recent pick-up in ordering activity in the country.

Metal and mining companies:

Reforms in governance will result into a transparent auction process of mining blocks rather than the current committee-based system of allocation of resources. This should help restart several projects, which have been stalled because of non-availability of resources.

However, similar to the Indian wireless telecom sector, the economics of the projects may be negatively impacted if the process of price discovery results in high upfront or recurring payments (royalty on revenue/profit sharing) for the resources. We are keeping a close eye on the judgment on this until we see the outcome of the first auctions for coal blocks, due in the next 2-3 months.



Equity

Historically across asset classes, equities have posted the best returns over long time periods. Over the last few years, negative real interest rate environment had attracted large share of household investments towards physical assets, resulting in a lower share of financial savings as a proportion of GDP. Moving to a positive real interest rates scenario, we foresee a rise in overall financial savings driven by larger allocations towards equity investments.

EPS and PE Contribution to Index Performance

Source: Bloomberg, CAAPL

In FY 2015 till December end the Index has appreciated by 24%, however PE rerating than earnings growth has been major contributor to the recent upsurge in the Indian equity markets. With markets fairly valued, the next leg of market appreciation has to be contributed by the Earnings growth.

Debt

On the domestic front we have seen significant improvement in major macro parameters – inflation, interest rates, CAD, fiscal deficit and external reserves. Inflation, which had been stubborn for past few years, has shown a significant easing. Commodity price correction, a slower increase in MSP and rural wages have paved the way for a lower inflation trajectory. Going ahead also we

see these factors to remain benign, keeping CPI inflation around 5%. With moderating inflationary expectations, RBI is expected to go for policy rate easing. We expect to see a 75-100 bps decline in rates over next 12 months.

Gold

-60%-40%-20%

0%20%40%60%80%

100%

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FYTD

EPS and PE Contribution to Index Performance

Nifty Index Returns EPS Contribution PE Contribution

Impact on various asset classes ?

This asset class is certainly tricky considering the myriad forces at work. We remain neutral as of now.

On one hand, USD strengthening is usually not favourable to Gold in dollar terms, but on the other hand it usually is, in rupee terms. However, in recent times, Rupee has stayed relatively strong vis-à-vis most global currencies except USD owing to portfolio flows which continue to be healthy. Such flows will continue as long as India is perceived as one of the few countries which remain promising for its domestic reasons. However, if USD strength persists, Gold in rupee terms may see-saw in its value and responds to eventual depreciation in rupee, especially if it is accompanied by a global risk-off. In such a case, Gold in rupee terms can once again take off.

As we speak, USD is almost near its 10 year trend line high and breaking out to the upside. We keenly join the rest of the world to see as to what happens from here.This can be a game-changer.

We can only hope USD reverses from here.



Avoiding risk is not easy. Managing it, is profitable !

v An advisor’s effectiveness is best identified by imagining his absence. In which case, clients may passively & independently manage their wealth by building a portfolio of deposits & ETFs of benchmark indices of each asset class.

v An advisor presence, therefore, needs to demonstrate additional value, over and above what a client could have done by himself. For example an advisor may add value by:

Ø Smoother navigation of markets

Ø Superior portfolio construction

Ø Effective risk management

Ø Timely achievement of objectives

Ø Frequent portfolio out-performance - Especially risk-adjusted portfolio performance.

v A few questions that need answers, though …

Ø How can a Client know whether an Advisor is adding value and if things are working in his favour?

Ø Are the Client’s objectives met in a timely manner with commensurate risk?

Ø Should there be a tool that can allow Client’s to measure and evaluate the value an Advisor adds??

Ø Should an Advisor be rewarded irrespective of performance?

Ø In case there are no clear answers to the above questions, will there be a trust deficit between the Advisor & the Client?

The client centric philosophy of “Advisory Value Add”



Advisory Value Add Components

v Relationship Value Index (RVI) – RVI is the moving value of a Client portfolio which is translated from an aggregate portfolio NAV on a daily basis. The RVI reflects the sum total of the effect of tactical asset allocation changes, fund or security selection, and any hedging or thematic decisions advised by the Advisor. The difference between the UCI or GBR and the RVI represents the total value added by Citadelle to a Client’s portfolio - which is called Advisory Value Add.

ØBenefit: This crystallises - in one graphical depiction - the sum total of all portfolio actions: Inflows/outflows, appreciation/depreciation of assets, risk management through portfolio re-balancing/staggering of investments, etc.

v Tactical Allocation Index (TAI) – Tactical Allocation Index (TAI) is a dynamic blended index that incorporates changes

Advisory Value Add Process

Advisory Value Add

Investment Committee

l Research Access l Views on Asset Classes l Asset Allocation Alpha

Product & Advisory

Committee: l Product Selection across asset classes l Fund Manager Alpha

Financial Strategy l Portfolio Construction l Execution l Risk Management Alpha

Risk Management Framework

"Advisory Value Add" process

v Goal Based Return (GBR) – GBR is the return required to achieve the goals identified during the financial planning exercise. This return or yield can determine the underlying asset allocation. Conversely, the asset allocation can determine the GBY based on the average return expectations of individual asset classes.

v Unique Client Index (UCI) – UCI is a blended portfolio comprised of indices that track a Client’s Strategic Asset Allocation performance. It is a blended benchmark based on the weights of the underlying asset classes. This index is rebalanced to its original weights at the end of every calendar quarter.




in the underlying asset allocation and sub asset allocation level in a Clients’ portfolio. It is made of the relevant indices that track the performance of every single security or fund in the model portfolio. Hence, the difference between the TAI and UCI represents the value added from tactical asset allocation changes recommended.

ØBenefit: This identifies the effectiveness of the ongoing tactical changes made to a Client’s long term asset allocation.

v Advisory Value Add (AVA) – AVA is the total outperformance of a portfolio’s return over and above its respective benchmark. This benchmark can be Unique Client Index (UCI) or Goal Based Return (GBR).

v Factors contributing to Advisory Value Add (AVA) – Advisory Value Add captures the impact of all the critical components of Advisory that fulfils a client’s goals and objectives through:

Ø Tactical Asset Allocation

Ø Manager Selection

Ø Risk Management

Ø Tactical Product /Thematic Strategies

v Clients can now be confident: The scientific framework of ‘Advisory Value Add’ brings in unprecedented transparency to the process of Advisory. In an industry where Clients are unable to establish the value added by an Advisor, it’s understandably difficult for them to pay Advisory fees or performance fees. The Advisory Value Add framework resolves this, as Clients can now be confident that value can be objectively established and rewards can be therefore linked to favourable outcomes. In our experience, the AVA process addresses the unspelt need of the

Clients to seek and embrace an Advisory relationship that is transparent and prioritises his/her interests beyond any compromise.




Advisory Alpha = All 3 Key Factors

Model Portfolio Tactical Allocation Index

Unique Client Index

A – Risk Management Alpha B – Fund Managers Alpha C – Tactical Advisory Alpha

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Relationship Value Index


Advisory Alpha = Transparency in Value Addition

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Static Blended Benchmark Relationship Value Index Unique Client Index

Advisory Value Add



Asset Class Sub-Asset Class Mutual Fund SchemesConservative Market Cap wise (%)

Strategic Tacticals Large cap Mid & Small cap Others

Equity - -PMS - -

Large Cap - -ICICI Pru Focused BlueChip Eq Fund - - 97.4 - 2.6UTI Opportunities Fund - - 98.1 1.9 -Mirae Asset India Opportunities Fund - - 80.5 12.2 7.3

Mid & Small Cap - -Religare Invesco Mid N Small Cap Fund - - 65.7 29.4 4.9HDFC Mid-Cap Opportunities Fund - - 74.9 21.2 3.9BNP Paribas Mid Cap Fund - - 62.3 35.6 2.2

Multi Cap - -L&T India Spl.Situations Fund - - 81.8 14.3 3.8ICICI Pru Value Discovery Fund-Reg - - 74.8 16.3 8.9Axis Midcap Fund - - 65.2 32.2 2.7

Thematic / Sectoral Funds - -Equity Hybrid Funds - -

Average Maturity

Years

Mod Duration

Years

YTM(%)

Debt 90.0% 92.5%Short Term 30.0% 30.0%

Axis Short Term Fund 10.0% 10.0% 2.1 1.7 8.7Franklin India ST Income Plan 10.0% 10.0% 2.6 2.3 10.5HDFC STP 10.0% 10.0% 2.0 1.6 9.7

Dynamic Bond Funds 30.0% 32.5%IDFC Dynamic Bond Fund-Reg 10.0% 10.8% 14.5 8.1 8.2SBI Dynamic Bond 10.0% 10.8% 13.9 7.4 8.4UTI Dynamic Bond Fund-Reg 10.0% 10.8% 5.2 NA NA

Income Funds 30.0% 30.0%DWS Premier Bond Fund 10.0% 10.0% 2.3 1.9 8.5HDFC Income Fund 10.0% 10.0% 12.9 7.0 8.4UTI Bond Fund 10.0% 10.0% 11.6 NA NA

Gilt - -Debt Hybrid Funds - -

Cash 5.0% 5.0%Liquid Funds - -

Ultra Short Term 5.0% 5.0%Gold 5.0% 2.5%

Gold 5.0% 2.5%Total 100.0% 100.0%

0.0%

92.5%

5.0%2.5%

Tactical Portfolio

Equity Debt Cash Gold

0.0%

90.0%

5.0%5.0%

Strategic Portfolio


Model Portfolio : Conservative





Equity 25.0% 25.0%PMS - -

Large Cap 25.0% 25.0%ICICI Pru Focused BlueChip Eq Fund 8.3% 8.3% 97.4 - 2.6UTI Opportunities Fund 8.3% 8.3% 98.1 1.9 -Mirae Asset India Opportunities Fund 8.3% 8.3% 80.5 12.2 7.3

Mid & Small Cap - -Religare Invesco Mid N Small Cap Fund - - 65.7 29.4 4.9HDFC Mid-Cap Opportunities Fund - - 74.9 21.2 3.9BNP Paribas Mid Cap Fund - - 62.3 35.6 2.2



Average Maturity

Years

Mod Duration

Years

YTM(%)

Debt 65.0% 67.5%Short Term 30.0% 30.0%



Income Funds 5.0% 5.0%DWS Premier Bond Fund 1.7% 1.7% 2.3 1.9 8.5HDFC Income Fund 1.7% 1.7% 12.9 7.0 8.4UTI Bond Fund 1.7% 1.7% 11.6 NA NA

Gilt - -Debt Hybrid Funds - -

Cash 5.0% 5.0%Liquid Funds - -

Ultra Short Term 5.0% 5.0%Gold 5.0% 2.5%

Gold 5.0% 2.5%Total 100.0% 100.0%

25.0%

65.0%

5.0%5.0%

Strategic Portfolio


25.0%

67.5%

5.0%2.5%

Tactical Portfolio


Model Portfolio : Moderately Conservative





Equity 45.0% 37.5%PMS - -


Mid & Small Cap 15.0% 7.5%Religare Invesco Mid N Small Cap Fund 5.0% 2.5% 65.7 29.4 4.9HDFC Mid-Cap Opportunities Fund 5.0% 2.5% 74.9 21.2 3.9BNP Paribas Mid Cap Fund 5.0% 2.5% 62.3 35.6 2.2



Average Maturity

Years

Mod Duration

Years

YTM(%)

Debt 45.0% 57.5%Short Term 30.0% 30.0%



Income Funds - -DWS Premier Bond Fund - - 2.3 1.9 8.5HDFC Income Fund - - 12.9 7.0 8.4UTI Bond Fund - - 11.6 NA NA

Gilt - -Debt Hybrid Funds - 7.5%

DSPBR Dynamic Asset Allocation Fund - 7.5% - - -Cash - -

Liquid Funds - -Ultra Short Term - -

Gold 10.0% 5.0%Gold 100.0% 100.0%

45.0%

45.0%

0.0%10.0%

Strategic Portfolio


37.5%

57.5%

0.0%5.0%

Tactical Portfolio


Model Portfolio : Balanced





Equity 70.0% 52.0%PMS - -



Multi Cap 10.0% 10.0%L&T India Spl.Situations Fund 3.3% 3.3% 81.8 14.3 3.8ICICI Pru Value Discovery Fund-Reg 3.3% 3.3% 74.8 16.3 8.9Axis Midcap Fund 3.3% 3.3% 65.2 32.2 2.7


Average Maturity

Years

Mod Duration

Years

YTM(%)

Debt 20.0% 43.0%Short Term 20.0% 20.0%


Dynamic Bond Funds - 5.0%IDFC Dynamic Bond Fund-Reg - 1.7% 14.5 8.1 8.2SBI Dynamic Bond - 1.7% 13.9 7.4 8.4UTI Dynamic Bond Fund-Reg - 1.7% 5.2 NA NA


Gilt - 0.0%Debt Hybrid Funds - 18.0%

DSPBR Dynamic Asset Allocation Fund - 18.0% - - -

Cash - -


Gold 10.0% 5.0%

Gold 10.0% 5.0%Total 100.0% 100.0%

70.0%

20.0%

0.0%10.0%

Strategic Portfolio


52.0%43.0%

0.0%5.0%

Tactical Portfolio


Model Portfolio : Moderately Aggressive





Equity 90.0% 75.0%PMS - -



Multi Cap 30.0% 30.0%L&T India Spl.Situations Fund 10.0% 10.0% 81.8 14.3 3.8ICICI Pru Value Discovery Fund-Reg 10.0% 10.0% 74.8 16.3 8.9Axis Midcap Fund 10.0% 10.0% 65.2 32.2 2.7


Average Maturity

Years

Mod Duration

Years

YTM(%)

Debt - 20.0%Short Term - -

Axis Short Term Fund - - 2.1 1.7 8.7Franklin India ST Income Plan - - 2.6 2.3 10.5HDFC STP - - 2.0 1.6 9.7

Dynamic Bond Funds - 5.0%IDFC Dynamic Bond Fund-Reg - 1.7% 14.5 8.1 8.2SBI Dynamic Bond - 1.7% 13.9 7.4 8.4UTI Dynamic Bond Fund-Reg - 1.7% 5.2 NA NA


Gilt - -Debt Hybrid Funds - 15.0%

DSPBR Dynamic Asset Allocation Fund - 15.0% - - -Cash - -


Gold 10.0% 5.0%Gold 10.0% 5.0%Total 100.0% 100.0%

90.0%

0.0%0.0% 10.0%

Strategic Portfolio


75.0%

20.0%

0.0% 5.0%

Tactical Portfolio


Model Portfolio : Aggressive


25January 2015

January 2015

Direct Equity Model PortfolioCompany Name

% Allocation Price Avg 3 yr

ROE (%)

Net Sales 3 Yr CAGR

(%)

Net Profit 3 Yr CAGR

(%)

Dividend Yield (%)

TTM P/E

Market Cap (INR Crs) Rationale

Axis Bank Ltd. 5% 502.05 18.9 26.6 23.5 1.4 10.9 118,648

Axis Bank is geared up to ride the next growth cycle with strong capitalization (12.6% Tier I), healthy ROA (1.7%) and expanding liability franchise (2,505 branches). Leveraging on the strong distribution network AXSB increased the share of retail deposits and CASA increased to 79% as compared 59% in FY11. It has delivered stable numbers with improving margins though economy was at a recovery mode. We remain confident of bank’s ability of strengthening its retail franchise further."

Bharat Forge Ltd. 5% 942.30 18.3 9.7 20.4 1.1 18.8 21,936

It is global leader in forging business having transcontinental presence across India, Germany and Sweden, serving several sectors including automotive, power, oil and gas,etc. CV business will benefit from pre-buying in US before emission norm changes and strong cyclical recovery in India. This coupled with scale-up in PVs would drive strong growth in Auto segment.

Crompton Greaves Ltd.

5% 187.65 5.6 10.4 -33.5 0.8 41.0 11,805

Crompton Greaves is part of the USD4b Avantha Group, and is a global leader in the management and application of electrical energy Crompton Greaves is aggressively focusing on increasing exports and leveraging the Indian manufacturing base.

Dewan Housing Finance Corporation Ltd.

5% 395.15 24.3 63.6 54.1 1.5 8.6 5,084Dewan Housing is a good play on Tier 2 and Tier 3 cities housing demand growth. Strong visibility on business growth and margins, superior asset quality, healthy provision cover and healthy return ratios augurs well for Dewan Housing.

Eicher Motors Ltd. 5% 15103.50 31.1 15.7 19.6 0.6 34.2 40,935

Eicher Motors is a leader in Cruise bikes in India and No.2 player in Medium Commercial Vehicles. The management has increased its production target to 280,000 units in CY2014 (from 250,000 units) and is expected that demand can reach 500,000 units in 3-4 years. Eicher Motors will invest Rs. 6 bn over the next two years in the Royal Enfield business to expand capacity in the Oragdum plant.

Gujarat Pipavav Port Ltd.

5% 206.50 9.8 LP LP 0.0 16.0 9,983

GPPV is favorably positioned on the West coast which enables access to the global trade route/rich northern hinterland. Strong parentage and robust evacuation further provides comfort. GPPV is expanding its container handling facility from 0.8m TEUs to 1.35m TEUs, which would be key driver of volume growth. In addition, higher throughput of liquid volume (2m tons capacity) would aid volume growth."

HDFC Bank Ltd. 5% 952.00 20.4 28.5 29.6 0.9 20.5 230,137 HDFC Bank is best-placed in the current environment, with a CASA ratio of ~45%, growth

outlook of at least 1.3x of industry and least asset quality risk.

Hero MotoCorp Ltd.

5% 3103.40 50.3 9.4 3.0 2.9 21.6 61,971

Strong franchise of Splendor & Passion, and wide distribution reach makes it best placed to tap strong demand growth, especially in rural markets. It is targeting exports of 1m units over by FY17 Post split from Honda, Hero MotoCorp is free to tap global opportunity in 2W.

IndusInd Bank Ltd. 5% 802.55 18.2 33.1 34.61 0.7 22.9 42,425

IndusInd Bank Ltd is one of the new generation private sector banks in India. Asset quality performance remains healthy, despite a challenging environment and significant slowdown in the CV segment.The management expects that the worst for CV financing is behind and gradual improvement is likely to be seen in coming quarters"

Kotak Mahindra Bank Ltd.

5% 1263.15 15.3 26.1 16.97 0.1 24.3 97,481

Kotak Mah. Bank is one of the fastest growing bank. Merger with ING Vysya Bank will be BV accretive for Kotak Mah. Bank at standalone and consolidated level. Merger places Kotak Bank in a sweet spot for the next growth cycle with strong presence across geographies, expertise in key product lines and continued healthy capitalization.

[email protected]

Text Box

For your reference only. Strictly not an advise


26January 2015

January 2015

Company Name

% Allocation Price Avg 3 yr

ROE (%)

Net Sales 3 Yr CAGR

(%)

Net Profit 3 Yr CAGR

(%)

Dividend Yield (%)

TTM P/E

Market Cap (INR Crs) Rationale

Larsen & Toubro Ltd. 5% 1496.50 16.1 17.8 3.05 1.1 24.1 139,002

L&T is well placed to capitalize on long-term infrastructure demand. L&T's order inflow prospects is expected to double from last year's level, to US$75bn. L&T’s preparedness to exploit the evolving India defence opportunity. The stock's underperformance vs. the BSE Sensex.

Lupin Ltd. 5% 1427.55 28.1 24.7 28.58 0.6 22.9 64,127

Lupin is amongst the larger pharma companies that is actively targeting the regulated generics markets. Strategy of focusing on niche, low-competition products for the US market likely to benefit in the long run. US generics is expected to grow 20-22% due to a rich generic pipeline.

Maruti Suzuki India Ltd.

5% 3328.30 13.2 6.3 6.74 0.6 26.3 100,541

Maruti is the best auto OEM play on macro-economic recovery in India. Following flat volumes for the past four years, we expect car sales to bounce back, led by high pent-up demand, economic recovery, and deceleration in car ownership costs. Maruti’s strong product pipeline, coupled with lower competitive intensity, should help it consolidate its leadership.

Thermax Ltd. 5% 1067.65 18.4 -1.3 -16.46 0.8 36.2 12,722

Thermax is benefiting from few structural trends: (1) energy shortages and inconsistent availability of power, driving demand for energy efficiency products, (2) hunt for alternative energy, given demanding regulations and improving viability, (3) increased environmental concerns and stringent regulatory intervention, (4) currency depreciation leading to increased possibilities of exports etc. Thermax is likely to report acceleration in revenue growth, driven by improvement in GFCF particularly in base industries) and interplay of several structural trends.

PVR Ltd. 5% 703.10 9.2 43.2 437.91 0.5 34.3 2,911

India’s largest and fastest growing multiplex chain with 23-25% bollywood market share and 33-35% Hollywood market share. Movie screening is an under-penetrated business in India and we believe PVR will be the biggest beneficiary of revival in discretionary spends.

Shree Cement Ltd. 5% 9412.10 23.7 162.0 712.58 0.3 32.1 32,789

Shree Cement is one of the most cost efficient cement producers in India. Shree Cement is the largest single-location integrated cement plant in North India, with an installed capacity of 13m ton.

Tech Mahindra Ltd.

5% 2591.55 25.0 54.2 60.13 1.1 13.8 62,192

Satyam's acquisition will help Tech Mahindra to diversify its client base and industry focus. Large deals like those of KPN and a gradual revival in the telecom vertical will help volume growth. Deals have kept growth coming (outside the BT account) despite challenged IT budgets in the telecom vertical.

TVS Motor Company Ltd.

5% 268.30 20.9 8.6 13.46 1.4 24.8 12,747

TVS is well positioned to benefit from the scooterization wave with its complete scooter portfolio. With international presence in more than 50 countries in Asia, Africa and Latin America it plans to launch multiple products across segments to reinforce and fill gaps in portfolio in next 2 years.

Ultratech Cement Ltd. 5% 2671.25 17.8 16.2 17.59 0.4 27.2 73,300

Ultratech is the largest cement company with pan-India presence. It has potential to increase its output without incurring major capex by increasing utilization and blending, along with locational advantage, gives it the flexibility to either export or sell in the domestic market. Significant potential to increase output by increasing blending. Allied businesses of white cement and RMC lend stability to overall performance.

VA Tech Wabag Ltd. 5% 1474.80 13.3 21.7 29.93 1.0 18.5 3,993

VA Tech wabag (VATW) is one of the leading players in water treatment industry, is attempting to expand into new geographies, including South East Asia, Sub-Sahara Africa, LatAm, Central Asia, etc. In FY14, the company received initial orders in Nepal, Tanzania, etc which also opens up interesting growth possibilities to ramp-up the business. Order intake in overseas subsidiaries has increased from INR6-7b in FY12-13 to INR16.4b in FY14

[email protected]

Text Box

For your reference only. Strictly not an advise



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Safe harbour statement !

Thank you for your time !

alpha edge - january 2015

Economy & Finance