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Dear Friends, recovery. The low base effect of Dec 16 and March 17 From mutual fund industry standpoint, we have our
quarterly results can push earnings growth to double tasks cut out for next year. We have to manage investor
As we close 2017, we are in an interesting situation. The digit for Dec 17 and March 18 quarter. However by than expectations. While a majority of investors are coming
fiscal deficit is increasing due to lower tax collections. momentum should pick up to push earnings growth reasonably well informed about the Volatility of returns
The crude oil price is on the rise. Domestic interest to double digit without base effect. It will be fair for and need for long term investment horizon, a minority
rates have moved up more than 100 basis points Investor to moderate return expectations in CY 2018 indeed is coming looking at the past performance. We
without any uptick in Policy rates. IPOs supply is at and be ready for volatility. It is also likely that stock have to caution them about potential lower nominal
all time high. And yet, our equity markets keep testing picking will deliver return rather than broad sector call. returns since equity markets are little above fair value
new highs. valuations.
One big theme which is worth relying not only in next
2018 will be a year of consolidation. We are unlikely year,but in years to come, is disruptor versus disrupted. Many investors tend to view mutual funds as equity
to see disruptive reform like demonetisation or GST We are seeing technology and other forces creating funds, and we need to market debt funds as well as
in the run up to election. These will allow economy disruption in business environment and sooner than we have done for equity funds, especially for retail
to benefit from the past reforms. The economy will later, it will start getting reflected into markets as well. investors. This will be a challenge especially when last
continue to face the hurdle of over valued Rupee till In every single company, in every single sector, you will 12 months savings account has given more return than
fundamentals prevail over flows and high real interest have to ensure that you are on the side of disruptor a bond fund. We need to stress on the need for asset
rates till transmission of lower rates is achieved. rather than disrupted. Not that every single disruptor allocation and longer-term investment horizon. We
company will be able to give you return. But if you are need to reinforce the message of regular investments,
Volatility will be order of the day for bulk of CY 2018. on the side where bulk of the companies are disruptor, especially to investors in semi-urban and rural areas so
Headwinds are building up in your chances of outperforming market increases that they can share the benefits of equity returns. We
the form of higher crude significantly. So the big theme for 2018 and onwards have to expand the distribution network by enrolling
oil prices, lower GST will be disruptor versus disrupted. new distributors.
collections, fiscal
slippage, high real In manufacturing, 3D printing and artificial intelligence The gap between the number of insurance agents
interest rates and is disrupting traditional models of manufacturing. In and mutual fund distributors needs to narrow down
deteriorating current services, robotics is disrupting human way of providing substantially for the funds industry to sustain its reach.
account deficit. services. So there is no sector which is outside the There is a need to develop models for small-ticket
Market towards 4 Q influence of technological and other forces of disruption. investors, and empower smaller distributors through
CY 18 will also witness One will have to be very careful in evaluating future technology for better analytical skills. We must drive
uncertainties related to business prospect as many disrupted companies will home the fact that mutual funds remain a low-cost,
2019 general election. get extinct like Dinosaur. when we are paying 20 times value-for-money product for the common man. The
Valuations which are forward earning, clearly, we are taking into account foundation has been laid for rapid growth in the years
priced for perfection next 20 years cash flow and a terminal value. And, if to come. But we need to keep on evolving to add value
are getting disruption is not going to be absorbed by the company, to our customers.
supported by then they may not remain in existence over that period
domestic of time. So it is not sector specific, company specific, Wishing you all a Very Happy and Prosperous 2018!
flows on the it is across the economy. You need to have companies
hopes of in your portfolio which are cognisant to disruptions. Nilesh Shah
earnings You want companies in your portfolio which are taking
appropriate steps to ride on the wave of disruption,
rather than remaining subdued and getting disrupted.

2017: the year
of reforms
progressive regulations, have all supported this shift in decided to refer some of the large corporate delinquent
INTRODUCTION savings behaviour. accounts to the NCLT (National Company Law Tribunal)
In the seventh decade of India’s independence, under the Insolvency and Bankruptcy Code in order to
India stands on the cusp of a major economic
revolution coupled with strong demographic We also believe that over time as the GST infrastructure find a time bound resolution to the NPLs.
dividend which could lead to unprecedented and rates stabilise, better compliance would ensure
growth in future. A greater access to the that there is an improvement in the tax- GDP ratio in 2017 was also the year of macro stability with most
internet and mobile connectivity along with
our country which would help us move further along macro indicators remaining largely under control. Even
an improving physical infrastructure, India’s
Gross Domestic Product (GDP) has witnessed the path of fiscal consolidation. while Real GDP growth was impacted by the effects of
a massive 10x growth in the last 25 years. As Demonetisation as well as GST implementation, other
India sets it eyes on to become the second In line with the shift of savings towards financial assets, indicators such as CPI inflation, Current Account Deficit
largest economy by 2050, the year of 2017 will
the markets have received tremendous support from and interest rates were largely benign. The stable macro
mark itself as the year of reforms which acted
as a strong foundation for years to come. Domestic Institutional Investors (DIIs) who were net trends along with growing comfort on political stability
investors to the tune of USD 14 Bn in 2017. Foreign and the continuation of the reforms agenda has led to
Institutional Investors (FIIs) too supported the markets a significant run up in the markets in 2017 even while
2017 can clearly be termed as ‘the year of reforms’. with net investment of USD 7.5 Bn into the Indian earnings growth remained subdued. Ratings agency
Reform measures such as GST (Goods and Services equity markets (data till Dec 28, 2017). Moody’s also upgraded India’s sovereign rating to Baa2
Tax), the Insolvency and Bankruptcy Code (IBC) and from Baa3 (the last rating upgrade by Moody’s was in
the flagship schemes like Direct Benefit Transfer (DBT) Another big development in 2017 were the steps Jan 2004). The pace of reform initiatives in the country
were some of the major initiatives of the year. 2017 taken to expedite the banking sector stress resolution. continues to remain strong and the Moody’s sovereign
started with the economy grappling with the after Large corporate Non Performing Loans (NPLs) have ratings upgrade is a recognition of the same. The large
effects of demonetization. This was followed by the been plaguing the banking sector resulting in eroding cap Nifty Index rose 28.73% and the Nifty Free Float
implementation of GST, which is by far the biggest balance sheet strength. RBI (Reserve Bank of India) has Midcap 100 rose 47.26% in 2017.
tax reform that the country has seen. While there has
been some temporary disruption in activity on account
Donald Trump Goods and Services Direct Benefit
of GST, we do believe that supportive global growth, becomes 45th Tax rolled out Transfer for
President of USA fertiliser subsidies
strong consumption demand (including revival in rural
demand) and improving corporate profitability would FEB AUGUST NOVEMBER
spur growth in 2018.

GST implementation has resulted in two large structural

thematic shifts in India which are still playing out: (a)
shift from the unorganized to the organized space
Union Budget RBI cuts Repo Insolvency and Bankruptcy
and (b) a shift in savings from physical to financial 2017-18 rates by 25 bps Code Ordinance 2017 passed,
assets. Favourable demographics combined with macro Announcement of Bank
Recapitalisation, Moody's
stability and initiatives to educate investors, as well as upgraded India's ratings
after 14 years

2018: the year ahead; focus 2018: back to basics;
focus on fundamentals
on fundamentals and As we enter the New Year 2018, as is customary,
we spend some time looking back at the year gone

corporate earnings
by and also attempt to gaze into the crystal ball
to understand what 2018 has in store for us. The
theme this 2018 is “back to basics” with a focus
on fundamentals and disciplined investing. In
this regard the quote from Benjamin Graham
seems very apt.
One of the key concerns in 2017 was that the up- resolution of NPLs and the repair of the balance sheets
move in the markets has not been supported by strong of corporate private sector banks and PSU banks would
earnings growth. While earnings growth has been play a role in the revival of private sector investments “Successful investing professionals are
disciplined and consistent and they think a
muted for the last few years, we now think that the in India. In this regard, the plan to infuse Rs 2.11 Trillion
great deal about what they do and how they do
trend is about to reverse and corporate earnings are set of capital into Public sector banks through a mix of
it.” - Benjamin Graham
for a recovery and such a recovery would be one of the recapitalisation bonds, capital infusion as planned in
main pre-conditions to the market sustaining current the budget and fresh raise from the market, stands in
valuations. This earnings recovery would in our opinion good stead. Over time as the resolution of big ticket
be led by the macro polices and reforms agenda, a boost NPLs gather pace, the cycle of low capital and low Growth at a Reasonable Price (GARP) with an aim of
to infrastructure spending, export growth supported growth could be broken, resulting in a pick-up in credit investing in companies which have the potential to
by global growth revival, a robust consumer demand growth. report earnings growth higher than the market, a strong
(including improvement in rural demand) and a nascent balance sheet position and stable management.
recovery in private capex. While 2017 was the year of reforms, in 2018 the
focus of the Government will be on consolidation and We would continue to urge investors to invest through
building on reforms like GST, bank recapitalization plan, mutual funds in a systematic manner for the medium
When we talk of bankruptcy and insolvency process and nurturing the to long term keeping in mind individual risk profile and
earnings recovery, a economy back into a higher growth path in a pre- return expectations.
recovery in overall
capital formation cycle election year. In this context we would also await
would be a key factor the recommendation of the Committee on Direct tax KEY RISKS
apart from growth in reforms with the focus on improving tax buoyancy and • Sharp and sustained rise in oil prices is a key risk to
consumption. compliance. the near term growth story for India
• Supply of paper: An acceleration in the supply of
While the key driver for capex in the economy would The later part of 2018, will see many states coming up paper in a bunched up manner could impact market
continue to be public spend, the private capex cycle for elections (8 state elections are slated to be held). performance
should also benefit from three years of low average In our base case, we build in a fairly stable political • Long bond yields are unlikely to retrace to lower
lending rates, better corporate profitability, easier scenario leading up to the General Elections in 2019. levels in a hurry and therefore any sharp and
availability of credit from the banking system, higher sustained spike in bond yields could impact the cost
equity raising from a buoyant market, more FDI into of capital.
Against this backdrop
manufacturing and infrastructure and a renewed focus
we expect the Nifty to • Any political instability as a result of the heavy
on housing. Public capex growth is likely to remain report ~15% earnings election calendar of 2018
healthy with a focus on roads, rural development and growth in FY19E.
affordable housing.
With improving corporate earnings, we too would
Apart from the factors mentioned above, the pace of continue to follow our investment philosophy of

gdp growth outlook:
gradual recovery keeping
macro stability in check
We expect real GVA (Gross Value Added) growth in
FY18e to be ~6.5% before improving gradually to
~7% in FY19E as many of the GST and demonetisation
related disruptions normalize out.
Gross domestic product

We expect consumption,
both urban and rural,
to be the main drivers
even as gross fixed
capital formation is Q2FY13 Q2FY14 Q2FY15 Q2FY16 Q2FY17
driven largely by public
spend. 7.34 8.81 8.01 7.53 6.3

High frequency indicators as well as some of the

indicators of rural demand are pointing to signs of Source: Bloomberg
recovery. Two-wheeler sales, tractor sales, diesel
demand, rural wage growth, demand for consumer
non-durables and usage of cash – all point towards
an improving rural economy. The monsoons in 2018
Table 1 : GDP growth outlook (%, GVA)
would however remain the key monitorable factor for a Real GVA FY16 FY17 FY18E FY19E
sustained improvement in rural demand.
Agriculture & Allied 0.7 4.9 3.2 3.5

The lagging investment cycle has been a cause of

Industry 8.8 5.6 5.5 6.0
concern as private sector capex remains muted. In
this regard, the steps taken so far for the resolution of Services 9.7 7.7 8 8.8
banking system stress would aid in cleaning up bank
balance sheets over the next 12-18 months and could Real GVA 7.9 6.6 6.5 7.0
help in the revival of investment activity through better Source : CSO; Kotak Estimates

availability of funds, albeit at a slow pace.

monetary policy outlook: policy
rates likely to remain on hold;
inflation data holds the key
The key focus for RBI’s monetary policy is to keep
inflation under check and to ensure that CPI (Consumer
Price Index) inflation remains close to the medium
term target of ~4%. It is likely that inflation stays CPI Core CPI
elevated in H2FY18 on the back of hardening food
prices and the pass through impact of the HRA (House 8.00%

Rent Allowance) hike post the implementation of the 6.00%

recommendations of the 7th Pay Commission. We 4.9%
expect CPI inflation to average ~4% in FY18E (March 4.00%
end inflation likely to be ~5%) and between 4.7-5% 4.88%
in FY19E.





Given this backdrop, we expect that policy rates would
be kept on hold for the medium term as the central
bank (RBI) would monitor domestic CPI inflation, trends
in fiscal deficit and the outcome of the policy actions Source: MOSPI
by the US Federal Reserve.

In terms of liquidity, the stance of the MPC (Monetary
Policy Committee) remains neutral. The excess liquidity
in the system which had peaked post demonetisation,
has been coming off with increase in currency in
circulation. The expectation is that liquidity would
remain marginally in surplus in FY18 while moving
YEAR Equity + Debt
(` in Cr.)
(` in Cr.)
closer to neutral levels by Q1FY19. RBI would however
continue to manage liquidity through the Liquidity
Adjustment Facility (LAF) and would also use open 2014 2,56,669 29,780
market operations (OMOs) if the need arises.

2015 65,277 66,816

2016 25,514 37,125

2017 1,96,040 91,353

Source: Bloomberg

currency outlook: mild depreciation
in `/$ likely; levers exist to control
currency volatility
The central theme for CY17 has been a relatively broad- factor in some weakness in the INR. The direction of the
based global recovery after having experienced global INR movement would continue to be USD determined forex reserves in India
disinflation shocks in 2014-16. With growth staging which in turn would be a function of GDP growth, now stand in excess of
some degree of a comeback, we should see some near inflation and policy rate movement and the balance USD 400Bn which could
term USD dollar strength in H1CY18 amid a relatively sheet tightening undertaken by the US Fed. The pace of be used to counter
more active Fed than the rest of G4 central banks and the narrowing of the real interest rate differential would any sharp currency
on tax reforms progress. also have an important bearing on the movement of
the currency.
We estimate FY18E CAD (Current Account Deficit)/ This together with strong policy headwinds and a
GDP to be at 1.8% and ~1.9-2% in FY19E (from 0.7% vigilant RBI would likely ensure low INR volatility.
of GDP in FY17). However, despite the widening of the
CAD, it is likely that the overall BoP in FY18E would
continue to remain in surplus on the back of capital
flows. We however do factor in some slowdown in flows
Emerging markets cross currency chart; % change YoY against USD
in the latter part of FY18 as real interest differentials
reduce putting some pressure on debt flows.

We expect the INR/USD to move in the range of 63 to
67 for the rest of FY18 and also build in a mild 2-3%
depreciation for FY19E. INR/USD has appreciated ~6%
(Dec 19, 2017, YoY basis). However, this has been in
line with the strength seen in most of the emerging -






market currencies against the USD. From here on we (5.0)



Source: Bloomberg; Change w.r.t. to Dec 19, 2017.

outlook on crude
oil prices

We expect oil price to

be range bound between
USD55-65/bbl and
average at ~USD60/bbl
Brent crude
for FY19. Oil demand
growth is expected to
be steady at ~1.5mn bpd
with steady oil price.

Dec-13 Dec-14 Dec-15 Dec-16 Dec-17

Increase in oil prices from the lows and higher than
110.8 107.76 63.7 56.82 65.12
USD50-55/bbl will result in increase in shale oil
production from US which will put a cap on the upside
for oil price. The extension of production cuts of 1.8mn
Source: Bloomberg
bpd by OPEC and few other large non-OPEC producers
like Russia up to end of 2018 will be downside support
to the prices. Risk on the upside if there is deterioration
of geo-political situation in Middle East particularly
that in Saudi Arabia, Iran and Iraq which will increase
the risk premium on oil price.

sector outlook
BANKING AND FINANCIAL SERVICES product segments, exposure to rural segments wherein Given this background, Life insurance companies could
BFSI has emerged as a large sector in the Indian in demand is showing signs of revival and a diversified see improvement in new business premium growth. Life
context with many subsets. Within this space, we are borrowing profile. insurance companies which have better distribution
structurally positive on retail private sector banks. The franchises and strong banc-assurance tie ups would
key theme supporting our view is the shift in market benefit. With structural improvement in persistency
share in loans and deposits towards these banks. This We anticipate a together with higher growth, New Business Premium
structural change in the banking system could continue structural shift towards (NBP) margins are also likely to improve resulting in
over the next few years aiding superior profitability financial savings which better profitability. General Insurance companies are
which would help support valuations. started as a consequence also in a sweet spot currently with better pricing trends
of the demonetisation and improving underwriting profitability.
With some signs of resolution of large ticket corporate drive to continue.
NPLs, the corporate private sector lenders would
likely benefit as credit costs moderates and growth
in corporate lending resumes. However, while the

initiation of the resolution process through the
bankruptcy code is a key positive, the pace of such
resolution could remain muted resulting in elevated
credit costs in the near term for these banks even as
incremental slippages reduce.
We would prefer better
capitalised corporate
lenders/ larger PSU
banks which also have
a robust retail liability

NBFCs have had a good run in CY17 as they benefitted

from lower cost of borrowings and higher growth.
Incrementally as we see liquidity in the system moving
from excess to neutral, it is likely that the cost of funds
for these entities would rise. Hence, one would need to
focus on those NBFCs which have pricing power in their

sector outlook
FMCG sector is likely to see the recovery in the first in the organised players gaining some share from the
half of calendar 2018 with rural growth showing unorganised segment as the price differential between
some early signs of recovery off late. A low base their offerings reduces. The higher pay-outs from the
courtesy the demonetisation and GST impact will government on account of the increased allowances
also ensure an optically higher growth for the first will also keep the service class having surplus money
half. Discretionary spends are likely to see continued to spend. We also expect large scale benefits for the
uptrends premiumisation is likely to take a faster poor towards the later part of the year as the general
route to growth. GST implementation will also help election nears. Thus the FMCG sector is poised for a
good 2018.

Infrastructure built-out is clearly amongst the top
priority of the Government, both Centre and State,
as reflected in heightened approval/order in Roads,
Railways, Urban Infrastructure, Airports, Housing, etc.
Recently, Cabinet approved ambitious Bharat Mala
project, enhancing NHDP programme. Certain large
ticket size infrastructure projects like Navi Mumbai
Airport, Mumbai Trans Harbour Link (MTHL) have
also been awarded. On the Urban Infrastructure front,
there is a meaningful activity on Metro projects in

all major towns with Mumbai taking lead in project

award and construction. Recently, Hyderabad Metro
was inaugurated by PMO. Other long term projects like
DFC, NamameGange, DMIC (Delhi- Mumbai Industrial
Corridor), River inter-linking, and expansion of regional
airport infrastructure would offer sizable growth
opportunity to players in the space. We would prefer to
play construction theme vs asset owners given better
business profile, low capital intensity, better asset turn
and relatively lower risk profile.

sector outlook
We remain positive on the automobile sector over We also expect the industry to see increased focus
the medium to long term as the sector growth has a towards electric vehicles and that will also keep up the
direct correlation with the economy growth outlook. excitement/nervousness in the sector high. Passenger
In contrast to last year, where urban growth led to the vehicles segment should see a continued growth in
sector revival, we expect rural growth to take the front the compact sports utility segment as well as more
seat this time around. Two normal monsoons, slight offerings in the mid segment sedan market.
inch up in minimum support prices, higher spends on
rural areas by government are all likely to result in
better growth in rural India. We expect the tractor
industry to see good growth continuing into 2018 as
well as rural focused utility vehicles to see an uptick.

We remain positive on the prospects of the cement 2017 was a challenging year due to increase in power
industry from a medium to long term perspective. and fuel prices which the industry has managed to pass
Cement demand which has been languishing between on through strong pricing. Going forward volume driven
4-5% CAGR range in last four years will likely improve pricing growth will be the key variable to watch out.
to 7-8% CAGR over the next three years. This will
be largely led by increased thrust of government on
infrastructure spend. While urban real estate market
continues to remain sluggish, demand from affordable cement
housing projects and “Housing for All” scheme in
urban/rural areas will result in strong cement demand
66.77% 67.58% 64.97% 64.75% 66.00%
Utilisation Utilisation Utilisation
Utilisation Utilisation

Cement industry utilizations have bottomed out in 254.87 270.42 275.20 289.43 304.68
Demand (mnt) Demand (mnt) Demand (mnt) Demand (mnt) Demand (mnt)
FY17 and we expect a structural shift upwards led
381.72 400.18 423.55 446.98 461.65
by declining pace of capacity additions coupled with Effective Effective Effective Effective Effective
Capacity Capacity Capacity Capacity Capacity
demand pick up. Pricing power is also likely to return
for the industry as incremental demand will be higher
than incremental supply from FY18E onwards and Source: IIFL Estimates
consolidation due to increased M&A deals in industry.
This in our view could lead to a structural improvement
in margins for the industry.

sector outlook
CY17 has been challenging for the Pharma sector due facilities are expected to come out of warning letters
to continued pricing pressure in US as well as muted and improvement in ANDA (Abbreviated New Drugs
growth in India. Pricing pressure due to increased Applications) approvals due to implementation of
competition and buyer consolidation and negative GDUFA (Generic Drug User Fee Amendment) timelines.
action by USFDA has impacted growth and profitability Growth rate in Indian market is expected to reach
of Indian players in US. Growth in the Indian market has earlier levels of about 12-13% for CY18.
been impacted due to inventory destocking because of
GST implementation. We expect players with USFDA compliant facilities
and large number of pending ANDAs to do better than
We expect that CY18 would see very gradual peers. We expect that players with higher exposure to
improvement for Indian players in the US market as key India compared to peers would be better placed.


We expect oil price to be range bound in USD55-65/ Gas sector is likely to see some stronger push from We continue to remain positive on OMCs as we
bbl and average at ~USD60/bbl for FY19. Oil demand regulatory side particularly on inclusion on natural expect refining business to have healthy margins and
growth is expected to be steady at ~1.5 mn bpd which gas under GST, pipeline tariffs revision and award and there is scope for further re-rating with marketing
is also positive for the refining sector. Capacity addition revised framework for new city gas distribution circles freedom staying and strong domestic demand growth
will keep pace with demand growth, which will help as the Govt. is looking to further increase the share continuing. If petroleum sector is brought under GST it
refining margins to sustain at current levels in next of natural gas in India’s energy mix. While domestic will be further positive but in our view chances of that
6-12 months while on medium term horizon of 1-2 natural gas prices have bottomed out and are likely to happening in 2018 are very remote. We are also positive
years, margins can further strengthen due to lack of any increase further (based on formula using combination on gas utilities as domestic demand will be stronger
major capacity additions. of international gas prices), it will still remain far due to lower gas prices, higher gas availability from
cheaper than alternate fuels. LNG prices showed regasification capacity additions and also domestic
production growth and Govt. policies favouring gas
surprising strength in 2H2017 after weak 1H2017 but usage.
going forward we expect LNG prices to move lower due
to LNG liquefaction capacity starts in US and Australia
for next 2-3 years.

sector outlook
We find risk reward unfavourable in this sector, Non-ferrous sector is relatively better placed due to
particularly in ferrous sector, as the profitability of constraints on supply. Aluminium prices will have cost
companies is largely dependent on the policies and support due to higher alumina and energy prices and
economic situation in China which at times become proposed capacity cuts in China if effected will give
unpredictable. While there is support to domestic steel further strength to the prices from current level of
prices due to safeguard and anti-dumping duties, the USD 2000/t which can sustain longer. Zinc prices had a
underlying demand growth is weak at 4-5% and hence, sharp run in the past 1.5 years due to mine closures and
fortunes of steel cos. will hinge on external factors such that may now remain steady at the current high levels
as market conditions in China. Capacity cuts in China of ~USD 3000/t.
for winter have supported the prices but restarts of
these capacities post winter can normalize the prices

The technology sector has witnessed single digit USD and acquire new capabilities even as growth in the
revenue growth in 2017 which has in turn resulted in traditional areas slows down dragging down overall
muted earnings growth for these companies. The sector growth. Automation is also the name of the game
has been facing headwinds which are both cyclical and given pricing pressure. IT firms so far have done a fairly
structural in nature. Looking into 2018, from a cyclical commendable job of maintaining margins through
demand perspective especially in North America (which various cost control measures even as revenue growth
is one of the largest geographies for Indian IT firms), it is stays muted.
likely that demand would start showing some signs of
pick up. Herein, BFSI as a vertical holds the key. In this scenario, we acknowledge that valuations in
the sector are attractive and most of the companies
Structurally the sector faces challenges as the nature generate significant cash flows and earn high ROEs.
of IT services shifts from traditional application However, given that growth revival would take place
development and maintenance work to more digital, only at a slow and steady pace, our focus would be on
cloud, analytics and consulting led projects. In this companies which have a higher proportion of revenues
respect, IT firms are seeking to reinvent themselves coming from new age digital projects and have been
able to carve a niche out for themselves.

intelligence: equity
key theme remarks
Large Cap – play on buying sectoral leaders that benefit from improving Kotak 50
investment climate

Diversified/Multicap – focus on sectors that are likely to benefit the most Kotak Select Focus /Kotak Opportunities Fund
across market cap

Infrastructure revival – “True-to-label” fund – recent thrust of Kotak Infrastructure & Economic Reforms Fund
government to revive the infrastructure theme

Through SIP in Midcap oriented scheme Kotak Emerging Equities Fund

ELSS – Equity allocation with ability to reduce tax outgo Kotak Tax Saver Fund

Balanced – benefit from debt and equity allocation Kotak Balanced Fund

we recommend investors to invest through sip/stp with a 5 years horizon

2017: the year of
ping-pong yields
Year 2017 was a roller coaster ride for the fixed income There was a sudden reversal in the yields post-April This rally did not sustain long as RBI MPC’s commentary
markets. The 10-yr benchmark sovereign yield moved 2017. With month-on-month CPI numbers slowing continued to be perceived as hawkish in both the
from 6.40% levels at the start of the year to 7.39% down and reaching a 5-year low of 1.54% in June 2017, meetings even with the announcement of 25bps rate
levels by the year end, i.e. a rise of almost 100 bps (i.e. markets built up an expectation of rate cut in the June cut in August 2017. This, coupled with RBI’s unabated
1%). and Aug 2017 RBI meetings. This led to almost 50bps bonds sales under Open Market Operations (OMO)
(0.50%) downward movement (read rally) in bond caused a major sell-off in the bond yields, Sep 2017
The policy changes and the resultant market yields. onwards. In FY18, till date, RBI has already sold bonds
interpretations too were quite mystifying through the worth Rs. 90,000 crores through OMO.
year. The RBI Monetary Policy Committee (MPC) at its
February 2017 meeting decided to hold the rates and
changed its stance from accommodative to neutral. The
MPC reasoned that the banks were flush with liquidity
post demonetization and the committee was focussed
on maintaining inflation within the targeted range. 10 year gilt (in %)

The MPC’s decision

dashed the market
expectations of a
rate cut and instead,
Dec-14 Dec-15 Dec-16 Dec-17
triggered a sharp sell-
off across the yields 7.85 7.76 6.40 7.39
Source: Bloomberg

2017: the year of
ping-pong yields
Despite positive events like India’s credit rating Indian economy has undergone large-scale structural
upgrade from Moody’s, positive outlook from S&P and changes in 2017; these changes will reap benefits in the
we do not expect to see
cancellation of RBI’s OMO sale, the sell-off in bond long run. But in the interim, these changes have caused
any grave or adverse
yields continued. RBI’s hawkish commentary and rising jitters and, to an extent, over-reaction in the Indian
impact on the bond
inflation numbers (CPI 4.88% in November 2017); the bond markets. We believe India’s macro-economic
yields in 2018.
US Fed’s December rate hike and a guidance of three story is evolving and with most of the pessimism
more hikes in 2018; hardening crude prices; expectations already discounted by the bond markets.
of fiscal slippage – all these factors eclipsed the positive
developments and continued to cause a sell-off. Amid
all this gloom, the silver lining was Foreign Institutional
investors (FIIs) who poured in a record INR 1.36 trillion

FED rate
in fixed income – which is higher than the cumulative
flows from CY 2013-2016!
Federal funds rate

Dec-13 Dec-14 Dec-15 Dec-16 Dec-17

0.25 0.25 0.5 0.75 1.5

Source: Bloomberg

2018: on to calmer,
smoother tides
A much-awaited credit rating upgrade from Moody’s coming year. A positive impact is already being seen differential terms) and INR over a period of time. The
and positive commentary from S&P’s were welcome in the form of a stable and appreciating INR. This larger concerns for debt markets in 2018 continues to
steps and are expected to have positive structural rating upgrade will likely take away good amount be – fiscal deficit and rising CPI.
impact on key factors including interest rates, in the of uncertainty risk premium from interest rates (in

Key drivers of interest rates:


At the beginning of this year, the government The market views on the pace of economy / The banking system is likely to remain neutral
had announced its focus on fiscal consolidation earnings recovery continue to remain diverse. to positive on liquidity. Despite that, the repo
and given a target of 3.2% fiscal deficit in FY18, Although there is a general acceptance of window will continue to be operational as it goes
with a glide path of 3%. But in October 2017 the various structural reforms undertaken by with RBI’s monetary policy stance. We expect the
itself, government spending reached 96% of its the government (i.e. bank recap bonds, GST, repo rate to remain at 6%.
fiscal deficit target (vis-à-vis 80%, same time last etc.), market conviction in growth and capital
year). This was partly due to shortfall in expected expenditure continue to be low. The recent uptick
GST revenue. in inflation, instead of being driven by growth in
demand / consumption, was driven by rising food
However, the government recently announced and fuel prices.
that spending for FY18 would exceed the
budgeted expenditure by Rs. 73,000 crores. This RBI has already lowered the GDP growth target
is likely to cause the fiscal deficit for FY18 to slip for FY18 from 7.3% to 6.7% - which still seems
to 3.5% (±0.2%), with an expectation of 3.2% a tad ambitious. Although GDP growth improved
(±0.2%) fiscal deficit target in FY19. from 5.7% in the June 2017 quarter to 6.3% in
September 2017 quarter, it would need to see a
Also, GST implementation is a structurally sharp jump in Q3 & Q4 for it to be at 6.7% for the
positive step which is likely to reap benefits as whole year. Such a sharp jump seems difficult.
we progress into 2018. Achieving the desired
efficiency through GST may well set India on the
path to becoming a mature economy, in the long

2018: on to calmer,
smoother tides

CPI Inflation rose from 3.58% in October 2017 to remain controlled due to US shale production
4.88% in November 2017 (15-month high). A rise and due to the likelihood of certain countries like
in food and fuel prices and a second order impact Russia preferring to opt out of the production freeze
of the implementation of House Rent Allowances agreement.
under the 7th Central Pay Commission primarily
caused this uptick. The food prices increased to We do not expect a sustained rise in inflationary
On the global front, the FOMC and ECB have 4.4% in Nov from 1.9% in Oct 17 and fuel prices pressures through the year 2018. Though the
started normalising their policy by hiking rates rose 7.2% from 6.1% in Oct 17. headline CPI number may touch the 6% mark due
and unwinding their balance sheets gradually. to base effect and HRA impact, it is likely to cool off
The economic impact of their actions will be Going forward, we expect the inflation to further subsequently. The only risk is due to crude oil prices,
seen over the course of 2018. spike up in December 2017, before cooling off in Q4 which may change the equation.
FY18, rising again in Apr-Jul 2018 quarter and then
With developed economies lacking inflation, the cooling off. With most of the large, global economies focussing
next year may see moderate growth rather than on harnessing renewable sources of energy, we do
acceleration. A look at the current yield curve This is under the assumption that crude prices shall not expect the high crude prices to sustain for long.
of US Treasury bonds shows a flattening yield remain range-bound in the $60-$70 / barrel levels . In fact, there exists a possibility that inflation may
curve (5-yr US treasury bonds @ 2.25% and 10- The OPEC nations have extended their production surprise on the down side, as indicated by Bloomberg
yr US treasury bonds @ 2.5%). We expect this freeze until June 2018. However, oil prices may estimates below:
flattening to continue and eventually over the
course of next 4-5 quarters result in an inversion
Inflation to Drop Back Below RBI’s 4% Medium-Term Target
of the yield curve. Though the US Treasury yield
curve may be pointing towards recession, the 10
CPI Inflation
Fed dot plot shows that 3 rate hikes are still on 12-Month Avg. Rolling
CPI Inflation
the table for next year. A growing developed
RBI’s 4% BE Estimate
Medium-Term Target
economy will help our exports, thereby making 7
our macro stronger.






*CPI projections include impact of higher housing rent allowance for central government employees
Source : Ministry of Statistics and Programme Implementation, Bloomberg Economics

interest rate
The year gone by has displayed excessive pessimism then the trajectory could lead to softer rates. 10 yr bond yields, but the future may be more toned down,
with respect to bond yields and has also discounted bond yields are likely to remain elevated at the current the perceived risk seems much higher than the real
negative news multiple times. We expect a more muted levels until either inflation shows a peak or monsoon risk. With most events already discounted for and
impact on rates in 2018. We base our interest rate augurs well for the inflation trajectory in the remaining crude remaining range-bound we do not expect to see
outlook for 2018 on the premise that crude prices will year. significant sell-off in bond yields in 2018.
remain range bound within $60 - $70 / barrel.
If there are no negative surprises for the developed
With crude remaining range-bound, the RBI may economies, then we are conservatively priced on the We go into the
overlook the rise in inflation driven by higher prices of curve and can deliver superior return across the curve New Year with an
food and fuel and settle for a long pause in interest depending on an investor’s risk appetite. expectation of a long
rates for the bulk of CY 2018. However, the current pause by RBI.
yield curve seems to suggest that the market has In a scenario where the past year has been hostile for
already discounted one rate hike.

From the fiscal deficit point of view we expect this

year to end with a fiscal deficit of 3.5% (±0.2%); we
expect the government to announce a glide path of Fiscal Deficit
3.2% (±0.2%) for the fiscal deficit in the coming year.
If the deficit target for the next year stays between
3.2% - 3.5%, the same should augur well for market

The yield curve is likely to remain steep till the time

we have clarity on peak inflation. The budget shall FY-15 FY-16 FY-17 FY-18 FY-19
provide the much needed fiscal clarity for the coming 4.1 3.9 3.5 3.5E 3.2E(+- 0.2)
year. With each inflation data-point, the trajectory may
change; but if the fiscal picture is around 3% - 3.2%
as promised and if the headline inflation undershoots, Source: Bloomberg

debt investment

• The short end of the yield curve is already steep and 01-Sep-17 6.75% 6.9% 15 bps 7.10% 7.35% 25 bps

has already priced in a lot of negatives. Thus, further 15-Dec-17 7.00% 7.35% 35 bps 7.40% 7.70% 30 bps
Spike in yields 25 bps 45 bps 30 bps 35 bps
steepening is unlikely. For instance, to get the same
yield as a current 6 Month Commercial paper (CP),
3 month CP will have to trade at 8% after 3 months,
which we assign a very low probability. (Average of • Thus, the steep curve, significant spike in yields and • For investors who have a 12-36 month horizon and a
6.5% & 8% = 7.25% which is the current 6 Month very low credit risk in this space makes it attractive moderate appetite for volatility and credit risk,
CP yield) for investors with a 12-36 month horizon. accrual funds can create an alpha over short-term
• Active fund management also has the potential to
HDFC generate alpha over FMPs with a 36 month horizon. • Funds to consider – Kotak Income Opportunities

Fund and Kotak Medium Term Fund.

01-Sep-17 6.40% 7.00% 60 bps
15-Dec-17 6.50% 7.25% 75 bps • Funds to consider – Kotak Bond Short Term and
Spike in yields 10 bps 25 bps Kotak Banking & PSU Debt Fund
• Thus, ultra-short term funds have the potential to STRATEGY #3: ACCRUAL FUNDS INVESTORS WHO CAN WITHSTAND
provide alpha over liquid funds with a 6-12 month – EARNING OPPORTUNITIES FOR VOLATILITY
• We believe that most of the negatives are priced
• Funds to consider – Kotak Treasury Advantage Fund; • The recent sell-off in bond yields resulted in a in, due to uncertainty. Any positive developments
Kotak Low Duration Fund; Kotak Corporate Bond parallel shift in the yields of AAA and sub-AAA on fiscal, inflation & PSU Bank recap in the medium
fund. assets. to long term would be a big positive for markets.

• With a long pause on rates by RBI and bank MCLR • Since sentiments are likely to remain subdued, we
STRATEGY #2: SHORT-TERM FUNDS - rates remaining unchanged, we expect a spread recommend investors to consider partial allocation
BETTER RETURNS POTENTIAL FOR LOW compression in the yields of AAA and sub-AAA towards duration funds but through the STP route
RISK INVESTORS assets. This, coupled with rating upgrade till March 2018.
opportunities provided by an improving economy
• The spike in 6-month yields and uncertainty over will allow investors in sub-AAA assets to earn from • Funds to consider – Kotak Bond Fund and Kotak Gilt
RBI action has also pushed the 1 year – 3 year rates capital appreciation. Fund
higher and is pricing in a lot of negatives making the
curve attractive.

intelligence: debt
segment scheme horizon
Conservative Investors – Ultra Short Term Funds Kotak Treasury Advantage Fund; 6 months – 12 months
Kotak Low Duration Fund;
Kotak Corporate Bond Fund

Investors with appetite for moderate volatility Kotak Bond Short Term; 12 - 36 months
and low credit risk – Short Term Funds Kotak Banking & PSU Debt Fund

Investors with appetite for moderate volatility Kotak Income Opportunities; 12 - 36 months
and moderate credit risk – Accrual Strategy Kotak Medium Term Fund

High Volatility – Active duration Kotak Bond Fund; 36 months (Participate through STP till Mar-18)
Kotak Gilt

This material should not be construed as an offer to sell or the solicitation of an offer to buy units of Kotak Mahindra Mutual Funds. We are not soliciting any action based on this material and is for
general information only. Before acting on any statement made or advice or recommendation in this material, clients should consider whether it is suitable for their particular circumstances and, if
necessary, seek professional advice. Investors should read relevant Fund information document and understand the investment objective, risk of such investment before investing. Past performance does
not indicate the future performance of the Funds of the Fund.

Name of the Scheme This product is suitable for investors who are seeking* Riskometer

Kotak Mahindra 50 Unit Scheme long term capital growth

Investment in portfolio of predominantly equity & equity related securities

Kotak Select Focus Fund long term capital growth

Investment in portfolio of predominantly equity & equity related securities generally focused on a few selected sectors

Kotak Emerging Equity Scheme long term capital growth

Investment in equity & equity related securities predominantly in mid & small cap companies.

Kotak Balance Fund Long term capital growth

Investment in equity & equity related securities balanced with income generation by investing in debt & money market instruments

long term capital growth

Kotak Opportunities Investment in portfolio of predominantly equity & equity related securities

Kotak Tax saver Fund Long term capital growth with a 3 year lock in
Investment in portfolio of predominantly equity & equity related securities

Kotak Infrastructure & Economic Reform Fund long term capital growth
(formerly known as “PineBridge Infrastructure long term capital appreciation by investing in equity and equity related instruments of companies contributing to infrastructure and economic
& Economic Reform Fund”) development of India

Kotak Gilt Investment income over a long investment horizon

Investments in sovereign securities issued by the Central and/or State Government(s) and / or reverse repos in such securities.

Kotak Bond income over a long investment horizon

investment in debt & money market securities

Kotak Low Duration Fund Regular Income over short term

Income by focusing on low duration securities

Kotak Medium Term Fund Income over a medium term investment horizon
Investment in debt, government securities & money market instruments with a portfolio weighted average maturity between 3-7 years

Kotak Banking and PSU Debt Fund income over a short to medium term investment horizon
Investment in debt & money market securities of PSUs, Banks & government securities

Kotak Bond Short Term income over a medium term horizon

investment in debt & money market securities

Kotak Treasury Advantage Fund income over a short term investment horizon
investment in debt & money market securities

Kotak Income Opportunities Fund Income over a medium term investment horizon
Investment in debt & money market securities

Kotak Corporate Bond Fund regular income over short term• income by investing in fixed income securities of varying
maturities and credit

* Investors should consult their financial advisers if in doubt about whether the product is suitable for them

Mutual Fund investments are subject to market risks, read all Fund related documents carefully.

As India’s growth engine becomes stronger, challenges
present themselves in the mask of opportunities. A land of
golden sparrow is ready to reach new highs with its laurels
resting on young, dynamic and efficient wings, which will
steer not just domestic growth but also global growth.