9th January 2012

WF : Equity confidence is badly shaken - and it seems to be more internal rather than external issues. CLSA's Chris Wood talks about a worst case of Sensex at 11,000 and the rupee at 60 to a dollar. What is your prognosis for equity markets in 2012 and what are likely to be the key drivers?

Sandesh : The confluence of high fiscal deficit, high current deficit ,high inflation and dropping GDP growth led to the large fall in the markets last calendar. The rising inflation led to consecutive monetary tightening by the RBI further impacting growth and corporate profitability. Indian GDP is a combination of domestic consumption, overseas services and domestic investments. The lack of domestic investments is reflected in the IIP slowdown. The domestic consumption and overseas services story seems intact. The improvement in the investment cycle is also dependent on the Indian government policy initiatives.

When I look at the market now, I think a lot of the above is priced in. The current market levels are pricing in a valuation of 12 to 13 times FY13 earnings. The low of FY 2009 was at about 11 to 12 forward earnings and this low happened due to the Lehman shock. I think the Global Central banks are far more cautious now and such failures would be averted. This time the financial markets failures are dependent on the eurozone sovereign defaults. While the haircut on these sovereigns are a distinct possibility I think the financial markets, Banks in particular, would ,in my view, get protected. The valuations therefore are near to the possible bottom. Indian currency market is the 5th largest with trades of over a trillion dollars. While current account deficit is rising I don't think a sharp fall in rupee after what we saw recently is possible. Our current account deficit financing over the long term has to happen from long term strategic flows rather than only portfolio flows.

WF : Is 2012 likely to be the year of the income fund? What is your prognosis for fixed income markets in 2012 and what are likely to be the key drivers?

Sandesh : The Current account deficit funding situation mentioned above would keep the currency in a depreciating mode . This would have an impact on the inflation. While the food prices have declined, a long term decline in food prices is more a structural issue. The global oil prices, unlike in 2008, may not see a steep fall in prices. I think the oil producers, who are mainly Governments and hence do not have any P&L pressure, would cut production if need be and hence would maintain the prices at the elevated levels. The RBI therefore has indicated an end to the rate hike cycle, it is difficult to see a steep fall in the policy rates from here. The repo corridor of 7.50% to 8.50% has a potential to come down by about 0.5% to 1% in the current calendar. The market is already discounting this with the 10 year gilts trading at 8.30-8.35%. The yield curve is inverse with the 1 year Bank CDs in the 9.5-9.7% band while the 5-10 year PSU bonds trading at 9.3-9.40%. I think the shorter end would come off gradually when liquidity enters. However I think we would continue to operate at the upper end of the repo corridor . The fiscal situation is worsening with fiscal deficit slipping to close to 6%. As the growth is not slipping big time, inflation not falling significantly, a large fall in policy rates is unlikely. We may however see yields slipping at the longer end by about 0.5% to 1% while at the shorter end the fall could be higher. A fall in CRR is likely in the current quarter to ease liquidity, that should drive the yields at the shorter end lower. The markets however would be volatile. Some portion of asset allocation should be at the longer end through the Income/Gilt funds.

WF : Business confidence within the distribution business is plunging to new lows - falling markets, falling volumes, falling margins and increasing regulatory intervention being some of the current issues. How do you see the road ahead for fund distribution?

Sandesh : I think a regulatory framework on distribution is clearly on the way. The accountability for distributors would be on the rise. Business confidence is a function of the underlying markets as well. The distribution business would always be key to the financial markets. The cost structure would have to be relooked as margins fall. A distributor would have to provide a wholesome financial solution to an investor.

WF : Should distributors bite the bullet and figure out ways to earn from their clients or can they reasonably expect to build their business models around trail income? If you were to look into a crystal ball, what revenue models do you see as sustainable in the future?

Sandesh : Distributors would have to look at a complete solution for the investor. Mutual fund could only be one of the products for fulfilling the investors financial needs. While earnings from mutual funds would come from trail earnings for other financial products the earnings would be transaction linked.

WF : What product segments within the MF category would you ask distributors to focus on in 2012, in a bid to increase sales momentum?

Sandesh : I would say all three verticals viz equity, fixed income and gold. After the steep fall of 2011 calender the confidence is shaken. It is bound to happen. The last year fall was the second worst fall in the last 20 years; the worst being that of 2008. The market has priced in all calamities. Asset allocation can only be a focus for a distributor. The rebalancing of the portfolio should always be done in the rising markets and not in a falling markets.

WF : We have seen a couple of AMCs coming out with process innovations that promise to make liquid funds more relevant for Indian savers and thus try and expand the MF industry's pie. How do you view these developments? Do you have similar plans to make liquid funds and income funds more convenient for Indian savers?

Sandesh : Yes we would be looking at it for sure. Technically mutual funds can fulfill all the requirements of an investor both at the shorter end as also at the longer end.

WF : What are your plans at Kotak Mutual Fund for 2012?

Sandesh : I think product bouquet is quite complete. The focus would be on producing quality performance across all our products. The focus on Equity funds would be to produce a reasonable alpha across their relevant benchmarks. We are planning to launch PMS products through the AMC.