Equity & Debt Strategy

Mid July – Aug’ 2017

Equity Market Update &

Equity MF Strategy

Confidential | 3

Nifty remained flat before GST implementation

16,800

17,000

17,200

17,400

17,600

17,800

18,000

18,200

9,400

9,450

9,500

9,550

9,600

9,650

9,700

01-Jun-17 07-Jun-17 13-Jun-17 19-Jun-17 25-Jun-17

NIFTY Index nsemcap index

RBI identifies

12 major NPAs

US Fed raises rate by 25

bps, Farm Loan waiver

in India

33.4

-2.2

10.0

3.0

-4.2

9.3

4.3 5.42.3

11.49.4 7.0

-10.0

0.0

10.0

20.0

30.0

40.0

Mar 17 Apr 17 May 17 Jun 17

FII DII incl MF MF

32,700

39,600

36,000 36,300

0

10,000

20,000

30,000

40,000

50,000

Feb 17 Mar 17 Apr 17 May 17

Both Large and Mid Cap index remain flat in June Both FII and MFs continue to be net buyers

Even after aggressive MF buying, their Cash holdings are

still high levels

Rs. cr

Source: Bloomberg, AMFI, KIE, Edelweiss As of 30th June 2017 YoY% unless specified

‘000 cr

Monthly Inflows to Equity MF back to 10,000 cr level

Rs. cr

6,462

5,310

8,842

10,208

0

2,000

4,000

6,000

8,000

10,000

12,000

Feb 17 Mar 17 Apr 17 May 17

Confidential | 4

50

174

138

222 vs 179 Exp

2.6

2.5 2.5

2.4 vs 3.6

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0

50

100

150

200

250

Mar 17 Apr 17 May 17 Jun 17

US Nonfarm Payrolls US Wage Growth

US macro disappointing, ECB policy and German elections key events to watch out for

USA wage growth disappoints , might lead to delay in next

Fed hike. Inflation also at 1.4% below 2% targetYields in Europe rose over fear of ECB taper

US Dollar index at lowest level since Trump election on

Euro strength and disappointing US macros

Source: Bloomberg

%

Opinion Polls for Merkel have improved in the last 4

months increasing optimism for Eurozone

Source: Bloomberg, As of 30th June 2017 YoY% unless specified

0.90

1.00

1.10

1.20

1.30

1.40

0.20

0.25

0.30

0.35

0.40

0.45

0.50

1-Jun-17 8-Jun-17 15-Jun-17 22-Jun-17 29-Jun-17

Germany 10 Year Yield UK 10 Year Yield

95.63

90.00

93.00

96.00

99.00

102.00

31-Mar-17 21-Apr-17 12-May-17 2-Jun-17 23-Jun-17

25.0

27.0

29.0

31.0

33.0

35.0

37.0

39.0

27-Feb-17 20-Mar-17 10-Apr-17 1-May-17 22-May-17 12-Jun-17

000s %

LHS RHS

Confidential | 5

Rural Consumption and Government spending showing green shoots

26.50 22.39

-15.88

52.42

72.10

-40.00

-20.00

0.00

20.00

40.00

60.00

80.00

Jan-17 Feb-17 Mar-17 Apr-17 May-17

Centre Expenditure (net of interest)

0.3

7.3

11.9

24.519.3

11.7

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Mar 17 Apr 17 May 17

2W Sales Tractor Sales

13.2010.70

5.50

30.00 30.33

23.28

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

2012 2013 2014 2015 2016 2017

Govt Expenditure – Spending has accelerated in 2017Consumption – Rural Consumption growing at healthy

rate

Indirect Tax Collection have significantly improved in

Modi Govt. regimeManufacturing – Weak due to low orders before GST

Source: Bloomberg, KIE, Nomura YoY% unless specified

52.5 52.551.6

50.9

45.8 47.2

45.2

47.0

40.0

42.0

44.0

46.0

48.0

50.0

52.0

54.0

Mar 17 Apr 17 May 17 Jun 17

India PMI - Manufacturing PMI - stocks of finished GoodsCY

Confidential | 6

Sectors which are expected to do well

Corporate Banks - Interest Rate Coverage of BSE 500

companies has improved

GST – Sectors with high unorganized share to benefit

Source Deutsche Bank, Credit Suisse, Nomura, Credit Suisse. YoY% unless specified.

Infrastructure – Apr 2017 Capital expenditure increased

by 38% YoY helped by Road and Urban Development

6.8 6.9 7.5 8.0

10.0

6.1 5.7 5.2 4.9 5.4

FY13 FY14 FY15 FY16 FY17

Median Interest Coverage Ratio of BSE 500 Average

0% 20% 40% 60% 80% 100%

Tyres

Soaps

Paints

Small Appliances

Electric Goods

Tiles

Plywood

Jewellary

Food Services

%

%

51%38%

101%

178%

-27%-50%

0%

50%

100%

150%

200%

RevenueExpenditure

CapitalExpenditure

Road MintryCapex

Defence MinistryCapex

RailwaysMinistry Capex

Agri - Rural wage growth has been very strong

8.6

3.00

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

Confidential | 7

Nifty @9771 Current 12M Forward PE 10 Year Historic Forward

Bloomberg P/E

ValuationBloomberg Consensus

KIE Estimate

Large Cap – Nifty 17.48 19.2 15-16

Nifty FY 17-18 Earningsgrowth

22.7%^ 10.6%

Mid Cap - Nifty Mid 100 19.40 - 13-14

Large vs Mid Premium -11.0% - ~+10%

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

Nifty trading at 19.2x one year forward earningsMSCI India P/E Premium over MSCI EM has actually

reduced to 38%

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

were above expectation while Pharma disappointed

Banking 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. ^ CY17-18

38%

34%

36%

38%

40%

42%

44%

46%

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

Feb 2017 Mar 2017 Apr 2017 May 2017 Jun 2017

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

12M Forward

PE

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

• Monetary Policy: Faster than expected monetary tightening in Europe and US

Risks

Confidential | 9

India Equities: Valuations & Strategy – Maintain Neutral Stance

At current levels of approx. 9771 (10th July, 2017), Nifty is trading at a 1 year forward PE of 19.2X. Also the ratio of potential upside to downside is biased towards downside at current valuations.

Risk-Reward Scenario based on earnings growth & valuations:

New Deployments:

Equities continue to rally to life time highs on theback of foreign and domestic liquidity. RuralConsumption and Government spending hasstarted to show signs of uptick. Due to otherEmerging markets also rallying and high consensusearnings expectation, MSCI India Premium hasfallen to 38% and is close to long term average.Going forward, we expect a 25bps rate cut inAugust RBI policy.

Mutual Funds: As Domestic Liquidity continue todrive market, we advise new investments inMutual Funds to be deployed 25% in lumpsumand subsequent 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 @ 9771 Fwd PE(X)Fwd EPS Estimate

Estimate Target

Nifty Level% Upside / Downside

1 Year Upside 18 588 Q4-FY19 10,584 8.32%

Downside 16 508 Q1-FY19 8,128 -16.82%

Debt Market Update &

Debt MF Strategy

Confidential | 11

Debt Market: Key Variables

Indicators

Policy Action

• We expect a 25 bps rate cut in August RBI policy

• The commentary from MPC members was relatively dovish

• One member pushed for 50 bps cut

Inflation

• CPI came at all time low of 2.18% in May 2017

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

• We expect CPI to remain below 2% in June and July

10 Year G-Sec Benchmark Yield

• 10 Yr yield likely to remain in range till policy outcome

Liquidity

• Liquidity surplus has reduced to Rs 2.6 trn plus

• RBI surprised the market with Rs. 10,000 cr of OMO sale

• Few more OMOs possible; Choice of bonds to impact market

• sentiment

INR

• Stable around 64.50

• Likely to remain in a range

Key Risks

• US policies; Fed hikes; Global monetary tightening

• Impact of 7CPC allowance implementation on CPI

• Strengthening of US Dollar

• Farm loan waivers can impact FD by 1.0 to 1.3% of GDP

G-Sec Supply

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

• SDL issuance of Rs. ~4 trn + expected; FY18

issuance expected to be Rs. ~1.2 trn

Confidential | 12Source: Bloomberg As of 30th June 2017

Bonds rallied post relatively dovish MPC commentary; however has risen marginally in July post surprise OMO sale

-11

-13-11 -11

-21

-20

-15

6.51

-25

-20

-15

-10

-5

0

6.00

6.40

6.80

7.20

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

Sp

read

(b

ps

)

% Y

ield

Bonds rallied post relatively dovish MPC commentary

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

2.18%

3.90%

Jul 16 Aug16

Sep16

Oct16

Nov16

Dec16

Jan17

Feb17

Mar17

Apr17

May17

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

Inflation fell to 5 Year Low, core inflation also below 4%

CPI

Core Inflation

2,605

0

1,000

2,000

3,000

4,000

5,000

31 02 04 06 08 10 12 14 16 18 20 22 24 26 28 30

Am

ou

nt

in R

s. B

n

RBI reduced Liquidity through Reverse Repo and CMB auctions

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

26

6.51

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 remain below average

Spread 10 Year G Sec Repo Rate

Confidential | 13

Strong macros and low inflation driving FII Flows

64.62

Jul 16 Aug16

Sep16

Oct16

Nov16

Dec16

Jan17

Feb17

Mar17

Apr17

May17

Jun17

64.00

64.50

65.00

65.50

66.00

66.50

67.00

67.50

68.00

68.50

69.00

INR remains stable around strong 64.5 level

Source: Bloomberg As of 30th June 2017

1.40

0.00

0.50

1.00

1.50

2.00

2.50

%

US Core PCE Inflation has fallen below 2% Fed target which can result in delay in the next Fed

hike 4,276

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

1111

58.84

48.77

0

200

400

600

800

1000

1200

Jul16

Aug16

Sep16

Oct16

Nov16

Dec16

Jan17

Feb17

Mar17

Apr17

May17

Jun17

30

35

40

45

50

55

60

65

70

US oil-rig count continues to rise

North America Oil Rigs Brent

$/bbl

Confidential | 14

Indian Debt market attractiveness has increased over last 1 Year

Source: NSDL, SEBI Bulletin, RBI, MFI

95.2%

92.1%

Jul 16 Aug16

Sep16

Oct16

Nov16

Dec16

Jan17

Feb17

Mar17

Apr17

May17

Jun17

60.0%

65.0%

70.0%

75.0%

80.0%

85.0%

90.0%

95.0%

100.0%

FII Debt Utilization has increased substantially and is close to 100%

Government Corporate

0.99

1.95

0.240.45

0.00

0.40

0.80

1.20

1.60

2.00

2.40

2015-16 2016-17

Upgrades have significantly outpaced downgrades in FY17, Downgrades skewed

towards few large Debt O/S

Upgrade/Downgrade Ratio By Number Upgrade/Downgrade Ratio By Debt OS

0

2,000

4,000

6,000

8,000

10,000

2015-16 2016-17

Share of bank financing has declined due to increase in Corporate Bond placements

Bank Financing Non-Bank Financing

Rs Bn

Jul 16 Aug16

Sep16

Oct16

Nov16

Dec16

Jan17

Feb17

Mar17

Apr17

May17

Jun17

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000Credit offtake by Mutual Funds has increased in

the last 1 Year

AUM - Credit Funds AUM - Dynamic Funds

Rs cr

Confidential | 15

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 | 16

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