Indian Equities-Seeking Multi-year Alpha

Indian Equities: Seeking
06 January 2015
What’s the Gist – While year 2014 saw markets rally on the back of hope
2015 brings an amazing opportunity for Investors in Indian equities to witness real revival of
the economy and participate in a multi
which I believe will play out over the next few years
portfolio with a goal of generating alpha consistently over the next 5 years.
Theme 1: Falling Inflation leads to Lowering
lately (CPI at 4.4% in Nov), largely due to easin
coupled with low IIP growth presents
Autos are the top picks among the sectors.
Theme 2: Revival in Economic activities leading to recovery in GDP
cut cycle begins, credit growth picks up which kick starts manufacturing and other economic
activities in an economy. Thus GDP growth revives.
Infrastructure, Cement and Capital goods among other.
Theme 3: Implementation of
government has been focused on bringing in new reforms and policies to get the economy
back on growth track. The government
amendment of Land acquisition bill,
Insurance FDI (Foreign Direct Investment) limit, GST (Goods and Sales tax) and Labour law
reforms are yet to be amended or approved. However, the government is likely to imp
majority of these reforms in the first half of its 5
benefited are the Power, integrated power producers for self use like steel, metals and
cement, Insurance companies and Industrial sector.
Theme 4: Global Commodities
economic growth remains sluggish as China (2
due to slowing investments and credit tightening. Euro zone economy remains fragile as they
continue to struggle to find way out of financial crisis hit back in 2008. However,
prices remaining low coup
global economy (ex China) is expected to gradually improve, which will see recovery in global
commodity prices as demand resumes.
Azharuddin A Mansiya
CFA Level 3 Candidate, June 2015
Phone: +91 9930307208
E-mail: a.a.mansiya@gmail.com
Indian Equities: Seeking Multi-year Alpha
While year 2014 saw markets rally on the back of hope
the economy and participate in a multi-year bull market. This report discusses four themes
which I believe will play out over the next few years and accordingly have designed a model
Theme 1: Falling Inflation leads to Lowering of Interest rates – Inflation has been falling
lately (CPI at 4.4% in Nov), largely due to easing food prices. Recent slump in crude oil pric
coupled with low IIP growth presents a perfect case for RBI to cut interest rates. Banks and
Autos are the top picks among the sectors.
Revival in Economic activities leading to recovery in GDP
activities in an economy. Thus GDP growth revives. Prefer cyclical sectors including
Infrastructure, Cement and Capital goods among other.
e 3: Implementation of key government reforms and policies
The government has already began with the coal blocks allocation and
dment of Land acquisition bill, While other major reforms like Mineral ore mining,
reforms are yet to be amended or approved. However, the government is likely to imp
majority of these reforms in the first half of its 5-year tenure, I believe. Major sectors to get
cement, Insurance companies and Industrial sector.
Commodities cycle recovers as global economy revives
economic growth remains sluggish as China (2nd
largest economy) continues to slowdown
continue to struggle to find way out of financial crisis hit back in 2008. However,
prices remaining low coupled with easing of monetary policies by respective central banks,
commodity prices as demand resumes. Sectors like metals and Oil & Gas will benefit.
While year 2014 saw markets rally on the back of hope of revival, year
year bull market. This report discusses four themes
and accordingly have designed a model
Inflation has been falling
ecent slump in crude oil prices
cut interest rates. Banks and
Revival in Economic activities leading to recovery in GDP – As interest rate
Prefer cyclical sectors including
– The new Modi
the coal blocks allocation and
hile other major reforms like Mineral ore mining,
reforms are yet to be amended or approved. However, the government is likely to implement
year tenure, I believe. Major sectors to get
as global economy revives – Global
largest economy) continues to slowdown
continue to struggle to find way out of financial crisis hit back in 2008. However, with crude oil
led with easing of monetary policies by respective central banks,
ectors like metals and Oil & Gas will benefit.

Page 2 | Azharuddin A Mansiya 6 January 2015
Table of Content
1. Theme 1: Falling Inflation leads to Lowering Interest rates---------------------------03
2. Theme 2: Revival in Economic activities leading to recovery in GDP-------------06
3. Theme 3: Implementation of key government reforms and policies---------------09
4. Theme 4: Global Commodities cycle recovers as global economy revives-----10
5. Multi-year Alpha portfolio: Sectors------------------------------------------------------------13

Theme 1: Falling Inflation leads to Lowering of Interest rates
As Inflation starts to ease… – Inflation, measured with CPI (Consumer Price Index) has been trending
downwards for past four months and it stands at 4.4% as of November 2014, which is within RBI’s
tolerance level. While this recent easing in inflation has largely been the result of lower food prices, recent
dramatic drop in crude oil prices have only accelerated the declining trend. As Global economy remains
fragile (Euro area struggling, Chinese economy cooling off), commodity prices including crude oil are
expected to remain weak in the near future. This will be beneficial for India as falling crude oil (used as
raw material in key products which also forms major component in CPI) will help to stabilize CPI at lower
levels.
Source: RBI
…probability of interest rate cut by RBI increases – RBI, who uses interest rates as one of the tools
to control inflation, has kept repo rate (the rate at which RBI lends to banks) at 8% since January 2014
after series of hikes in 2013. This has helped in controlling inflation to some extent, however it has come
at the cost of slowing growth of the economy. As illustrated in Exhibit 2, when inflation starts to ease, RBI
cuts interest rates with the lag of few months, however 2013 was an exception where despite high
inflation, RBI had reduced and kept rates lower due to slow economic growth (which was more like
stagflation) during the period.
With inflation now easing and growth struggling to resume, RBI is expected to cut rates sooner rather
than later, with earliest rate cuts expected post budget in 2015.
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
Jan12
Apr12
Jul12
Oct12
Jan13
Apr13
Jul13
Oct13
Jan14
Apr14
Jul14
Oct14
CPI
Exhibit 1: Inflation trend

Source: RBI
As interest rates reduce, credit growth picks-up…. – Bank credit growth has been slowing since 2011
soon after repo rate hikes. As per the data published for September month by RBI, credit growth has
slowed down below 10% yoy for the first time in 5 years. As per Exhibit 3, credit growth has picked up
when rates have stayed below 7%. Slowing inflation rate and weak IIP growth presents a classic scenario
for RBI to cut rates to kick start credit growth and gradually the economic activities.
Source: RBI
7.0%
7.3%
7.5%
7.8%
8.0%
8.3%
8.5%
8.8%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
Jan12
Apr12
Jul12
Oct12
Jan13
Apr13
Jul13
Oct13
Jan14
Apr14
Jul14
Oct14
Reporate
CPI
Exhibit 2: Repo rate vs Inflation
CPI Repo rate
4.00%
4.75%
5.50%
6.25%
7.00%
7.75%
8.50%
9.25%
8%
13%
18%
23%
28%
33%
38%
43%
Apr01
Oct01
Apr02
Oct02
Apr03
Oct03
Apr04
Oct04
Apr05
Oct05
Apr06
Oct06
Apr07
Oct07
Apr08
Oct08
Apr09
Oct09
Apr10
Oct10
Apr11
Oct11
Apr12
Oct12
Apr13
Oct13
Apr14
Oct14
Reporate
Creditgrowth-3mma
Exhibit 3: Credit growth vs Repo rate
Creditgrowth Repo rate

…leading with interest sensitive consumer loans – Auto demand, especially 4-wheelers is supported
by lower interest rates as consumers generally go for financing the purchase of their cars. As the below
chart suggests, auto loans pick-up when repo rates are reduced and vice versa. Auto loans were up in
October by 21% yoy, driven largely by festive demand. However, as rates are expected to be reduced in
near future, demand for autos will pick-up soon.
Source: RBI
Playing the theme – The first half of 2015 will see the start of interest rate cut cycle in the economy and
to play this trend I suggest taking exposure into Banking and Auto sector by investing regularly in the first
6 months to earn maximum returns. Banking and Auto stocks generally outperform broader market during
the interest rate cut cycle (Exhibit 5). Among banks, private sector banks are preferred due to better asset
quality and capitalization ratios. However, investors with high risk appetite can consider investing in public
sector banks (PSBs) as government works towards resolving their balance sheet issues beginning 2015.
Additionally, PSBs are trading at cheaper valuation than their private sector peers. Among the autos,
prefer to invest in 4-wheelers segment with domestic exposure followed by commercial vehicles. For retail
investors to play this trend, I suggest to take mutual fund route by investing in Bank and Auto sector/focus
funds. For conservative investors, investing in long-term debt funds is preferred over bank fixed deposits
and PPFs as the return generated will be far superior in debt funds.
Source: RBI, BSE India
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
10.00%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
Apr2008
Oct2008
Apr2009
Oct2009
Apr2010
Oct2010
Apr2011
Oct2011
Apr2012
Oct2012
Apr2013
Oct2013
Apr2014
Oct2014
Reporate
Autoloangrowth-3mma
Exhibit 4: Auto loans growth vs Repo rate
Auto loans Repo rate

Theme 2: Revival in Economic activities
Falling interest rates encourage demand for loans… – Interest rates hold key to ignite engine of
growth in an economy. Presently RBI has kept repo rates constant at 8% since the start of 2014 which
has led to constant falling loan growth in manufacturing sector from the high of 33% yoy in Jan-2014
down to 18% yoy in Oct-2014. As interest rates starts to fall (as discussed in theme 1), demand for loans
to finance manufacturing activities will accelerate, as illustrated in exhibit 5.
Source: RBI
…leading to improvement in Industrial output – Index of Industrial Production (IIP) is an indicator used
to measure the combined economic output of the goods manufactured by various industries and sectors
in India. A higher IIP number indicates growth in economic activity supported by demand for goods
produced. While IIP growth is driven by the demand situation in the economy, credit growth in
manufacturing sector acts as a leading indicator of potential future growth in IIP output.
As indicated in exhibit 6, IIP improves with increasing loan growth, since manufacturers need finance to
create capacities for production and other operational needs. With credit growth poised to pick-up, IIP will
soon recover, improving the growth outlook in the economy.
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
10.00%
0%
5%
10%
15%
20%
25%
30%
35%
Apr08
Oct08
Apr09
Oct09
Apr10
Oct10
Apr11
Oct11
Apr12
Oct12
Apr13
Oct13
Apr14
Oct14
Reporate
Loangrowth-3mmayoy
Exhibit 5 : Repo rate vs Manufacturing sector loans
Manufacturing sector loans Repo rate

Source: RBI
Recovery in IIP will boost GDP – Gross Domestic Product (GDP) is a measure of total economic output
produced in form of physical goods as well as services in a country. It an indicator of overall growth
situation in a country. A strong IIP growth suggests eventual revival in overall economic growth improving
GDP growth. Historically, when IIP growth resumes, GDP growth revives almost simultaneously (Exhibit
7). As IIP growth is expected to bounce back, GDP revival will soon follow. However, the quantum of
growth will depend on interest rate cuts along with other macro-economic factors including government
reforms and global factors.
Source: RBI
0%
5%
10%
15%
20%
25%
30%
35%
-10%
-5%
0%
5%
10%
15%
Apr2008
Oct2008
Apr2009
Oct2009
Apr2010
Oct2010
Apr2011
Oct2011
Apr2012
Oct2012
Apr2013
Oct2013
Apr2014
Oct2014
Loangrowth-3mmayoy
IIP-3mmayoy
Exhibit 6: IIP vs Mfg sector loans
IIP Manufacturing sector loans
-10%
-5%
0%
5%
10%
15%
20%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
1Q07
3Q07
1Q08
3Q08
1Q09
3Q09
1Q10
3Q10
1Q11
3Q11
1Q12
3Q12
1Q13
3Q13
1Q14
3Q14
1Q15
IIP-quarterly3mmayoy
GDP%
Exhibit 7: GDP growth vs IIP
GDP IIP

Playing the theme – IIP growth resumes within 2 quarters while GDP takes 3 to 4 quarters to revive post
the first instance of meaningful rate cut. During this course of revival, core industrial sectors like capital
goods, consumer durables segment and construction activities will lead the recovery cycle. As consumer
spending gradually rises with improving GDP, consumption driven industries like food, clothing, travel,
entertainment and allied sectors will gather the growth momentum. For investors seeking to generate
alpha on their portfolios, it is advisable to remain overweight on capital goods, cement and consumer
durables sectors. Retail investors can best benefit by investing in mutual funds focused on these specific
sectors. The maximum alpha can be derived from this theme is by investing before the growth revives
and staying invested through the entire growth cycle.
Source: BSE India

Theme 3: Implementation of Key Government Reforms and Policies
With new government comes new reforms… – Policy reforms are much needed to ensure that India
transitions out from stagflation to an environment of higher growth and lower inflation. Indeed, the
decisive (Lok Sabha) election outcome suggests that the new government will be able to implement
reforms at a faster than previously expected pace. Easing land acquisition rules, raising foreign
investment limits in insurance and pension sector, introducing a country-wide goods and services tax
(GST), privatization of coal sector and a separate labour law for small factories are few of the major
reforms the new government is looking to implement in its tenure.
…with new reforms comes new hurdles… – The government had lined up an ambitious legislative
agenda for the just concluded Parliament session. The long-pending insurance legislation to raise the cap
on foreign investment to 49 percent from 26 percent, and another bill to replace a decree to overhaul the
coal sector, were considered low-hanging fruits that PM. Modi hoped to push through parliament's winter
session, but it did not make much headway because of its lack of strength in the Rajya Sabha.
…and with new hurdles comes new solutions – After failing to see the key bills passed in Rajya
sabha, government is now likely to opt for the ordinance route to take some of that forward – insurance,
coal and mining. The Union budget is expected to provide a big push forward in terms of drawing up
framework for key policy reforms that the government is proposing to get the economy back on track. Two
things that they need to be pushed in 2015 are GST and revival of mining activity. These two are very
critical. Infrastructure sector needs a huge facelift.
Playing the theme – The new Modi government is focused on infrastructure development and economic
growth. In order to achieve this goal, the government has taken some steps in the right direction and are
looking more than willing and capable of achieving it. To this end, they have already laid the plan for
auctioning of coal mine blocks. Insurance FDI bill and Mining bill to auction iron ore mines will be cleared
ordinance route. GST (Goods and Sales tax) is also expected to be implemented as early as FY17. All
these reforms will improve the business conditions and fundamentals which in turn will improve their
productivity once the economy revives. The key sectors to benefit include Power, Metals, Insurance and
Manufacturing Industries. Investors are advised to begin investing in Metals and power, followed by core
industrial sectors.
Source: BSE India, RBI

Theme 4: Global Commodities cycle recovers as global economy revives
China is dragging global growth down… – China’s slowdown is being led by a decline in spending on
infrastructure and housing. And, of course, if there is a slowdown in Chinese growth and demand for raw
materials and such, that's going to be another massive shake to the global economy.
…and Euro zone is further adding to the pain – With growth of just 0.2% in the third quarter of 2014
and an annual inflation rate of 0.3% in November, Eurozone problems of slowdown and deflation seems
to have prolonged their stay. With a backdrop of weak growth, low oil prices and general lack of
inflationary pressures, the ECB’s (European Central Bank) battle against deflation looks to continue well
into 2015.
However, lower Oil price helps stimulate demand… – In the summer of 2014, a barrel of Brent crude
was trading at $115 a barrel. By Christmas it could be obtained for barely half that price. The big drop in
the oil price is positive for global growth. It puts more spending power in the hands of consumers and it
cuts costs for businesses. Global growth should gradually pick up as lower Oil prices should be able to
tame inflation which in turn should enable central banks to ease monetary policy to stimulate growth.
However, this would affect governments, such as Russia, Venezuela and Iran, that can only balance
their books if the oil price is at $100 a barrel or more.
…which can be further nurtured through monetary measures… – ECB is expected to announce
further easing measures in form of QE in 2015 to stimulate demand. However, the recovery will be
gradual, probably after second half of 2016.
Rapid growth in China supported the world economy during the recession, but it was created on
investments and supported by debt, neither of which is healthy. The fact that fixed asset investment
growth dropped to 16.1% from 20% in 2013 while retail sales remained more or less stable (growth was
down by 1.3%), suggests that demand is finally beginning to catch up with supply. Indeed, consumption
now accounts for a record 48% of China’s GDP. This is really good news as China’s economy gradually
transitions away from investment driven to consumption driven and in the process, cuts down on public
debt.
…Leading to recovery in commodity prices – As Global economy growth recovers, demand for
commodities picks-up, driving their prices up. Rising commodity prices, especially crude oil will reverse
the inflation cycle, i.e. inflation will start to rise (refer exhibit 10, 11 and 12).

Source: IMF
Source: IMF
0
20
40
60
80
100
120
0.0
1.0
2.0
3.0
4.0
5.0
6.0
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
CrudeOilpx(US$/bbl)
GDP(%)
Exhibit 10: World GDP vs Crude Oil
World Crude Oil
0
50
100
150
200
250
0.0
1.0
2.0
3.0
4.0
5.0
6.0
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
IMFWorldMetalsIndex
GDP(%)
Exhibit 11: World GDP vs Metals Prices
World IMF World Metals Index

Source: IMF
Playing the theme – It will take couple of years before the global growth picks-up and I see this theme
playing out from 2017 onwards. As commodity prices start to recover supported by growth, inflation will
start moving upwards, prompting central banks to start tightening interest rates. In such a scenario,
commodity producing sectors and defensive sectors tend to outperform. Investors are advised to move
out of their long term debt investments and start increasing investments towards metals, oil&gas sectors,
followed by defensive sectors like Pharma and FMCG.
10
30
50
70
90
110
2.0
3.0
4.0
5.0
6.0
7.0
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
CrudeOilpx(US$/bbl)
Inflation(%)
Exhibi 12: World Inflation vs Crude oil
World Crude Oil

Multi-year Alpha Portfolio – Sectors
Year 2015 – Remain bullish on sectors like Autos, Banks and Consumer durables as I see onset of
theme 1 in the year 2015. Additionally, Cement is expected to outperform, as construction demand picks-
up due to infrastructure development in the country. Remain bearish on metals, oil & gas and steel
sectors due to global commodity downturn cycle.
Year 2016 – Remain bullish on sectors like Autos, Banks, Consumer durables, Capital goods and
Cement as theme 1 continues to play on along with the onset of theme 2 and partial visibility of benefits of
theme 3. Continue to remain bearish on metals, oil & gas and steel sectors due to global commodity
downturn cycle. Additionally, I believe FMCG sector will tend to underperform the cyclical sectors.
Year 2017 – Remain bullish on sectors like Autos, Banks, Capital goods, Cement, Infrastructure, Steel
and Power as Theme 2 plays out while benefits of theme 3 continues. Remain bearish on FMCG and
Pharma sector on their relative underperformance to cyclicals.
Year 2018 – Remain bullish on commodity linked sectors like Metals, Steel and Oil & Gas as Theme 4
plays out. Remain bearish on Cement and Power sector as they will be trading at or near peak of their
cycle.
Year 2019 – Remain bullish on defensive sectors like FMCG, IT and Pharma as Theme 4 continues to
play out and as the cyclical peak out. Remain bearish on all cyclical sectors as inflation rises, pushing
interest rates upward, slowing the credit growth.
Note: Overweight = Sector will outperform broader market (BSE Sensex), Neutral = Sector will perform in line with the broader
market and Underweight = Sector will underperform the broader market.

Disclaimer: The views mentioned in this report are based purely on my own independent analysis, research and understanding.
None of the content including data and views are based on any of the research reports of any brokerage houses. Model portfolio
composition is dynamic in nature and is subject to change as per the changes in the macro-economic situations and risks
associated. Investors are requested to take advice before acting upon any investment ideas mentioned in this report.

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