SPECIAL REPORT

Outlook for
2015
If the much anticipated rate cut materialises, long-term debt funds are
likely to challenge the supremacy of equity funds this year. Devotees of

N
gold may be a little disappointed, though.
ew Year and forecasts are
inseparable twins. In the
beginning of the year, every
investor wants to know how
her investment would fare in
the next 12 months. We have
three experts to discuss the
prospects of three different asset classes
equity, debt and commodity.
Sankaran Naren, Chief Investment Officer,
ICICI Prudential Asset Management
Company, says equity investors shouldnt
expect a repeat of higher returns in 2015.
However, he believes that there are many
pockets of value in the market domestic
capital goods and infrastructure, utilities and
rate-sensitives that still offer great value to
investors.
On the other side, Amandeep Singh
Chopra, Head of Fixed Income at UTI
Mutual Fund, believes that policy rate cuts
by the Reserve Bank of India are a certainty
now, and gilt funds will continue to top the
performance charts in in 2015. So far gilts
have rallied on expectation of rate cuts. Now,
the actual event is likely to happen, he says.
Gopal Agarwal, Chief Investment Officer,
Mirae Asset Global Investments, says
investors wont make great returns in gold in
2015. He says investors should consider buy-
ing commodity stocks if there is no addition-
al increase in royalty or taxes. Indian com-
modity stocks do seem to be close to their
bottoms and may not have much downside
based solely on the underlying commodity
prices, he says.

Mutual Fund Insight February 2015 39

 SPECIAL REPORT

Sankaran Naren Amandeep Singh Chopra Gopal Agarwal

Chief Investment Officer Head of Fixed Income Chief Investment Officer
ICICI Prudential AMC UTI Mutual Fund Mirae Asset Global Investments

40 Mutual Fund Insight February 2015

Sankaran Naren
Equity
Forecast
2015
Your call in August 2013 to buy
equities and in 2014 to take
positions in long-duration gilt funds
proved to be spot on. Where should
investors place their bets in 2015?
The call on equities today is a very
difficult one. Stock markets have
already moved ahead of the econo-
my. The outlook for the economy
over the next three to five years is
very good. But the outlook for 2015
is not so clear. The economy could
improve and the market could
match it. Or the economy could do
well and the markets could lag
behind. Essentially, what we are
telling people is that in 2014 equity
returns are not likely to be repeated
in 2015. But the outlook for the
next three years looks quite good
because in this period youre going
to see industrial production growth
and credit growth pick up, the
capex cycle come back and the fis-
cal deficit fall due to higher growth.
In fixed income, I would say that
the one year outlook appears
extremely good. We find the
chances of the RBI cutting interest
rates in 2015 very high. With the
recent fall in crude oil prices, the
parameter that RBI is watching
consumer price inflation looks
likely to moderate very sharply.
From the Wholesale Price Index, in
fact, it looks as if we are in a defla-
tionary environment.
Therefore, people who want to
invest with a one-year view may
find comfort in fixed income. Those roads, ports and railways. In our
with a three-year view may find view, growth has to be driven by
equities very attractive because
once rates fall, the capex cycle is
purely domestic infrastructure-relat-
ed capex.
likely to pick up. Then equity
returns may show improvement. The recent oil price fall has been an
unexpected bonus for the economy
In equities, you have sounded
warnings on mid- and small-cap
valuations, isnt it?
in recent months. How will company
earnings be affected by this?
The short-term impact will be nega-
Yes, the valuation gap between tive, but the long-term implications
large-caps and mid- and small-caps will be quite positive. There are
has narrowed to a large extent. This three short-term impacts that we
is because 2014, especially the sec- can see. First there is an inventory
ond half, saw more domestic fund impact on oil marketing companies;
flows than foreign fund flows into they may have to take short-term
the market. Foreign money usually losses. Then there is the possibility
seeks out large-cap stocks and of lower inventory holdings. If oil
domestic money tends to be con- prices arent going up, why would
centrated in mid- and small-caps. companies hold so much invento-
Therefore, mid- and small-caps ry? Three, you must remember that
have tended to do much better than for every buyer of oil, there is also a
large-caps during in this period. seller. Therefore, because of prices
However, today, it appears to us declining, he is going to suspend
that there is no case for a shorter- either his expenditure or his invest-
term investor to go into mid- and ments. These factors will cause a
small-caps rather than large-caps. near-term negative impact on earn-
ings. But if you put together lower
In infrastructure, what are the sub- oil prices and lower interest rates,
segments where you see potential? Indias balance sheet will suddenly
With the commodity cycle down, begin to look very attractive. Weve
capital expenditure (capex) is seen equities not doing too well in
unlikely to be undertaken in oil and recent weeks. This could be due to
gas or metals. Why would anybody the negative short-term implications
put up new capacity in this sce- of falling oil.
nario? Further, metals, oil and gas
and cement are all suffering from Now that rate cuts look quite likely,
oversupply and may not see capex. are you betting on rate-sensitive
Therefore, you must look at pure sectors?
infrastructure segments such as Yes, we are. We are playing it
through sectors, such as power util-
ON Taking a call on equity is very
EQUITY difficult today. Markets have moved
MARKET ahead of the economy. The outloook
for the economy in the next three to
five years is good. But the outlook
for 2015 is not clear.
Mutual Fund Insight February 2015 41
 SPECIAL REPORT
ities, which have regulated returns
and thus can benefit from lower
rates. There can also be big borrow-
ers in other sectors who can benefit.
Rate cuts may not benefit banks
alone, as everyone seems to assume.
Is the US interest rate hike in 2015
a worry?
It will not have much of an impact.
Everyone is worried about it
because of the Indian experience
with currency volatility in 2013. But
in 2013, India had a current account
deficit of 5 per cent when US start-
ed tapering its quantitative easing.
But now our CAD is likely to be
much lower (02 per cent). In any
case, nominal interest rates in India
are far higher than those in the US. I
think the US rate hike will have a
far greater impact on Europe and
Japan. If their rates are zero and US
rates are 0.5 per cent, thats a small
differential. For India, the rate differ-
ential is as high as 6.75 per cent.
But this is not the consensus view. I
find most people quite worried
about it. I think the 2013 memories
are too deep.
Do you think retail participation in
equities will continue?
There is so much money invested in
real estate and gold that this is
bound to happen. It may be difficult
to reallocate past investments, but
incremental investments will come
into equities.
Overall corporate earnings have
been disappointing for two years
now despite all the talk of a
recovery. Do you see this changing?
I dont expect improvements in the
first half of the year. The impact of
inventory losses on commodity
companies and the postponement
of capex in some sectors may hit
earnings.
42 Mutual Fund Insight February 2015
Do you expect foreign portfolio
flows into India to pick up in 2015?
I think emerging market funds as a
class may see outflows. We think
emerging markets are a broken asset
class. Too much of the benchmark
for emerging markets is weighted in
Brazil and Russia, which are
affected by oil and iron ore price
declines. Most emerging markets
have commodity linkages. Mexico
has oil exports, Indonesia has coal
exports, China has a credit bubble.
This creates scope for India to
receive money, but the process may
take time. We believe global funds
may move out of emerging market
funds into India-specific funds.
Amandeep Singh Chopra
Debt
Forecast
2015
In 2014, gilt funds were the top-
performing category of debt funds.
Can the high returns of gilt funds be
sustained in 2015?
Yes. I think gilt funds can still be
the outperforming debt fund catego-
ry in 2015. So far gilts have rallied
on expectation of rate cuts. Now,
the actual event is likely to happen.
In 2014, the market moved from a
bearish, risk-off kind of mood to a
more positive one. For much of
2014, if you recall, the debate was
about high inflation and whether
RBI would remain neutral or even
hike rates a little bit more.
It was only towards the end of
the year that this view changed. So,
the rally we saw in the ten-year gilt,
caused by its yield correcting from
8.7 to a little below 8 per cent, was
nothing more than recalibration of
those expectations. Our view is that
2015 will see a rate cut of about 50
basis points, with another 50 basis
point cut likely in 2016.
Has the market already discounted
those rate cuts?
At about 7.8 per cent (yield on the
ten-year G-sec), we believe the mar-
kets have already discounted one
rate cut. But as the year progresses,
people will have greater conviction
in further cuts and the gilt rally
may extend further. We believe that
if you build duration on your debt
portfolio, either through gilt funds
or income funds, it can outperform.
As gilt funds usually have higher
duration than income funds, they
can deliver better returns.
Currently, there seems to be no
risk of a change in this outlook.
Even in its recent monetary policy
statement, the RBI had articulated
that we could have the monetary
policy tuning accommodative early
in 2015. With inflation already on a
downward trajectory, there should
be enough leeway for the RBI to cut
rates. This should pave the way for
gilt funds to deliver a double-digit
return in 2015.
Last year you were more cautious
about betting on a rate cut. Have
you changed that view?
Yes. But even now, though we see
rate reductions definitely happen-
ing in 2015, the timing of the move
is uncertain. Some see it happening
in January, some in February; others
feel it may be done just after the
budget. But with the event being
inevitable now, the portfolios have
to be positioned for it.
FII flows into Indian bonds depend
on the interest rates here being
high. Will worry about FII flows
force the RBI to defer rate cuts?
It is not just interest rate differen-
tials that prompt FIIs to invest in a
country. The key factor driving
money into India has been that
among emerging markets, India has
among the best economic parame-
ters today. Growth is picking up;
inflation is coming down. Interest
rates are also relatively high as
compared to other emerging mar-
kets. If you look at other emerging
markets, China is slowing down
and has low rates. Brazil is facing a
significant slowdown and Russia
risks recession too.
So, I think we can live with, say,
a repo rate of 7.5 per cent and still
attract capital flows. Even if the US
Fed hikes rates to 1.25 per cent,
which is the key expectation, we
would still have a differential of
6.25 per cent, which is quite good.
Whats your view on the current
account deficit and the rupee?
Bloomberg estimates suggest that
most people expect a very stable
rupee this year, with some even
forecasting appreciation. Thats not
our view. We dont think rupee will
appreciate on a sustained basis. But
we dont see the volatility continu-
ing. For the financial year ending
March, we expect the CAD at
1.41.6 per cent of GDP. This is
being driven by a big collapse in the
crude oil import bill.
Does it make sense to own
corporate bonds now? Do they
trade at a sufficient spread over
government securities?
In the middle of November, five-
year corporate bonds traded at just
30 basis points over gilts. Now the
average is 70 odd basis points. At
spreads of 7585 basis points, cor-
porate bonds are attractive.
Though we see rate reductions
ON
INTEREST happening in 2015, the timing
RATES of the move is uncertain. Some
see it happening in January,
some in February, others just
after the budget.
Do you think liquid fund returns can tainty, people will not want to give
fall sharply in 2015 due to the cut up on whatever gold they hold. The
in rates? loose monetary policies of the
Yes, we think liquid funds will not European and Japanese central
outperform in 2015. If you consider banks may also support gold prices.
a 50 basis point rate cut, it will On the other hand, as the US dollar
immediately be reflected in the strengthens, that will weaken the
reinvestment yields of liquid fund case for gold, US dollar being the
portfolios. Most of them sit on just reserve currency for most nations.
two-month maturity. Therefore, Overall, I think these factors will be
when they reinvest that money balanced out and will make sure
theyre going to earn yields of 7.75 that gold trades close to its cost of
to 8 per cent as compared to over production this year. The average
8.5 per cent now. That is why we cost of production for gold in key
have been advising investors to producing countries is about $1,125
have a higher allocation to longer an ounce. This is about the level
duration funds. where gold can trade. Events can
cause gold prices to fall below this
for short periods, but that event
Gopal Agarwal may not sustain.
Commodities We have also seen sharp falls in
prices of industrial metals like
copper, zinc, lead and even steel.
Forecast What is the outlook for them?
Industrial metal prices have been
2015 falling for some time now and I
now believe they are quite close to
their costs of production. Across
commodities, whether it is iron ore,
Gold has delivered a negative coal, aluminium, copper or zinc, I
return in 2014 and has not looked think that declines from here will
up even with episodes like the be capped at 10 per cent or so. The
Russian crisis. What is the outlook outlook next year will depend large-
for gold in 2015? Can global prices ly on global growth, which to my
fall below $1,200/ounce? mind is uncertain. But if you have a
2015 will be another year of volatil- three- or four-year view, you can
ity for gold. You will not make great build positions. At the same time,
returns in gold because many fac- industrial commodities usually can-
tors are acting on it. On the one not trade more than 20 per cent
hand, in this environment of uncer- above their costs of production. If
Mutual Fund Insight February 2015 43
 SPECIAL REPORT
they do, new supplies or produc-
tion eventually come in to reduce
the price.
Whats your view on oil, as it has
fallen to $60 levels?
For the last year and a half, I have
held the view that the oil market is
fundamentally over-supplied. But
prices have only fallen now. But
supply apart, you have to recognise
that US consumption of oil has
already fallen from 20.7 million bar-
rels to 18.9 million barrels. US pro-
duction of oil has gone up from 7.4
to 9.08 million barrels. Secondly,
the European demand is flat.
Therefore, there has been a slow-
down in demand and a production
increase which has resulted in a 1.5
million barrel surplus in the oil
market. Unless that excess is taken
out of the market, oil will remain
fundamentally weak.
Then, a lot of speculative money
has also gone out of all commodi-
ties. Speculators mainly follow
price performance. The moment
they see no appreciation, alloca-
tions are reduced.
Should investors buy stocks of
commodity companies now?
Indian commodity stocks do seem
to be close to their bottoms and
may not have much downside
based solely on the underlying
commodity prices. But one risk that
investors in India have to factor in
is the government deciding to
ON CRUDE
PRICE
44 Mutual Fund Insight February 2015
impose additional taxes or royalties
on commodity companies.
Currently tax collections are low.
We need to see how bidding goes
on in natural resource auctions. If
there is no further increase in royal-
ty or taxes, this is not a bad time to
buy commodity stocks. We were
underweight on commodity stocks
in our diversified equity funds. We
plan to use the volatility in markets
to buy commodity stocks.
If oil remains below $65 for the
next six months, I do see a sell-off
in the Indian stock market. If oil
remains at low levels, sovereign
wealth funds from the Middle East
will resort to redemptions and the
world capex will go for a toss.
In India, the other issue is that
commodity companies have borne
the brunt of all such problems as
coal scam, iron ore mining ban and
so on. Regulatory issues are also
quite many with the sector. Global
investors may not prefer to invest in
Indian commodity stocks because
the commodity companies in devel-
oped markets often offer better divi-
dend yields and are better plays on
global commodity prices than
Indian companies. If India resolves
the issues surrounding commodity
companies in coal, oil and so on,
the allocations may increase.
Whats your view of China? Though
the market does not look very
expensive, everyone appears to be
bearish on it.
It is appropriate to evaluate this
If oil remains below $65 for the
next six months, there will be a
sell off in the market. Sovereign
wealth funds from the Middle East
would resort to redemptions, and
world capex will go for a toss.
only from the point of view of the
Hong Kong market, which is institu-
tion driven. The Hang Seng is quite
stable. In China, the consumption
story is greatly under-estimated in
my view. Chinas per capita income
is $7,000 a year. There is demand
for high-end products. Plus,
Chinese inflation has fallen to 1.5
per cent recently and may decline
further. There is likely to be a fur-
ther rate cut. The government is
also doing everything right to create
one crore jobs every year. This will
boost demand in China and the sec-
tor that will benefit will be mainly
consumer goods. This is one seg-
ment of the Chinese market where
you can make very peaceful returns.
But right now, there is a lot of
pessimism about China. So is it
best to stay away from
manufacturing and export-oriented
sectors there?
Yes, absolutely. Fixed capital for-
mation in China is a function of
new factories and homes being
constructed, which is slowing right
now because of slower export
growth. However, I do feel that
there is too much scepticism about
China. If the world is not growing,
how can China grow in isolation?
It is an $8.6 trillion economy. Even
if it grows at 7 per cent, it will cre-
ate more output than the US.
Today, even Indian consumption
growth is 1 per cent. The only
problem with China is that it has
grown too fast in too short a time.
Now there is a global slowdown
and therefore there is a painful
process of re-adjustment. This is
not very different from what
Indian power, infrastructure and
other businesses are going through.
But China is equity funded and
has $4 trillion of forex reserves. It
cannot simply collapse.