Bond is Back - Copy

Bond is Back

Kotak Mutual Fund Update as on 6th August, 2015

Factors Affecting the Bond Market
Bond Market Rally

RBI interest rate outlook Positive demand/supply equation

Low Inflation Growth moderate High Bank FII Demand
imperative Gilt Deposits

Supply

Agri-supply Low crude oil Slowing Better quality Increasing Increased Forex
investment Fiscal Deficit financial auction limit outlook
outlook Prices integration
cycle

• Most of the factors in the market remain positive for the rally.
• The forecast of weak monsoon and consequent impact on agri-supply finds concern in the

market.
• The impact of impending US Fed rate hike is also fettering the market rally.

CPI Inflation Outlook: To Head Below 5%

• We largely concur with the view that CPI inflation is on a downward trajectory

in the medium term.

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Agri-Supply Outlook –Normal Monsoon

Monsoon Report

650 • The normal June-July rains

June- July Month Monsoon Trend
600 have boosted the sowing

season

550

(mm) 500 • Normal rains have also

reduced the likelihood of agri-
450 supply shock this season

400 • However, the risks of El-Nino

JUN-JULY
350
June-July 2015- rains remain going forward as per
Average

300 3% below avg IMD forecasts

250

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1919
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1939
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1949
1954
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1969
1974
1979
1984
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1999
2004
2009
2014

RBI has deferred further rate cut until the entire monsoon season plays out. This will give
them sufficient data to gauge agri-supply situation and inflation trajectory.

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Comfortable Minimum Support Price

Kharif Season MSP FY2015 FY2016 % gain • The government Minimum support
price (MSP) increases on food crops
Pa ddy Common 1360 1410 3.68% have largely been deflationary, as
Pa ddy (F)/Gra de'A'# 1400 1450 3.57% against the previous trend
Jowa r-Hybri d 1530 1570 2.61%
Jowa r-Ma l da ndi 1550 1590 2.58% • The procurement policy is largely
Ba jra 1250 1275 2.00% conservative
Ra gi 1550 1650 6.45%
Tur (Arhar) 4350 4625 6.32% • This eases the concern of a populist
Moong 4600 4850 5.43% spending
Urad 4350 4625 6.32%
Groundnut 4000 4030 0.75%
Sunflower Seed 3750 3800 1.33%
Se s a mum 4600 4700 2.17%

The MSP this year may reduce money circulation and stimulate production in
inflation causing commodities.

Agri-Supply Outlook - Upsurge in Sowing

Area sown Area sown in %

Crop this Kharif last Kharif Improveme

Season Season nt

Rice 227.81 214.82 6.05%

Pulses 82.44 68.15 20.97%

Coarse 148.49 125.5 18.32%
COielsreeaelds s 148.52 135.6 9.53%

Sugarcane 47.33 46.42 1.96%

Jute & Mesta 7.78 8.11 -4.07%

Cotton 101.91 104.84 -2.79%

Total 764.28 703.43 8.65%

in Lakh hectares. Source: Ministry of Agriculture

• Given sufficient rainfall distribution, the sowing has improved this year.

• At that, the one time MSP bonus for the pulses has seen the sowing for this segment
increase sizeable.

• We believe that good sowing trend and satisfactory rainfalls have reduced agri-supply
risk

• At that, Since CPI inflation tends to spike from shortages in pulses and vegetables, this
sowing pattern may address that issue.

Gilt Supply Side Improvement…(in Rs Lac Crore)

2015-16 (E) 2016-17 (E) 2017-18 (E) 2018-19 (E)
144
GDP 162 183 207
Fiscal Deficit 3.60%
Gross 3.10% 3.00% 3.00%
Borrowing
6.37 6.73 7.41 7.9
Redemption 1.82 2.31 2.57 2.43

Net Borrowing 4.55 4.42 4.84 5.47

•Insurance and Provident Fund demand is sufficient to take care of Fiscal Deficit
•Long Term Demand trend is bullish for rates, particularly at the long end

Demand Supply Equation (in Rs Crs)

Gross Debt Supply

Central Government 6,13,096
State Government 1,75,000
Total 7,88,096

Gross Debt Demand Remarks

22% SLR incremental & 13%

Banking System 2,46,824 Deposit growth

Banking System replenishment of maturity Assuming entire maturity is
Life Insurance
EPFO-PFs 1,75,000 converted into SLR

1,96,611 15% NBP Growth

66,300 Approx 15% Growth

General Insurance 8,000 12% Premium Growth
Total Structural Demand 6,92,736

•FII limits expectedGtaopincrease by Rs 35000 Cr - 95,360To be filled by FII, MFs

•Banks are maintaining 28% SLR given low credit demand. Therefore real demand can be

higher

•MF demand also will fill the gap

•Overall excess supply adds pressure but Macroeconomic fundamentals drive rates down

Long Term G Sec Demand (in Rs Crs)

FY 2015-16 FY 2016-17 FY 2017-18 FY 2018-19 FY 2015-16 FY 2016-17 FY 2017- FY 2018-

Investors (E) (E) (E) (E) (E) (E) 18 (E) 19 (E)

MF 7,60,624 8,81,868 10,22,437 11,85,414

Banks 92,24,179 1,03,58,753 1,16,32,879 1,30,63,723

PF 12,24,008 14,39,188 16,92,198 19,89,685 73203.2 86072 101204 118994.8

Insurance 21,90,547 27,72,575 35,09,248 44,41,655 183938.8 232811.2 294669.2 372962.8

Total 1,33,99,358 1,54,52,384 1,78,56,762 2,06,80,477 257142 318883.2 395873.2 491957.6

•Assuming 40% of AUM growth will go in purchasing Gilt(both SDL and Gilt) by insurance and
PF

•Assuming historic growth rate of 15.9% for MF, Banks at 12.3% , PF at 17.6%, Insurance at
26.6%

Expected FII Limit Increase

Current Untap FII Average Current Increas
FII ped Limit Dollar Rupee Dollar Extent e In FII
Exposur FII in $ Rate when Rupee of Limit
e (in Rs Limit Total FII Billion limit were Rupee due to
cr.) in Rs Limit in given/ Deprecia resettin
cr.) Rs cr.) increased (in tion (in g (in Rs
Rs cr.) %) cr.)

Government Bonds 1,22,427 261 1,22,688 25 49.0752 63.6 14.5248 36312

Government Bonds

(Sovereign) 29,132 5 29,137 5 58.274 63.6 5.326 2663

Total 38975

As on 30 June 2015

• Market has latent inflow potential from FII since the Rupee depreciation since last imposition of limits
has created cushion for further FII inflows

• Governor has indicated that limit changes may happen sooner than later

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Foreign Exchange Fundamentals

130.00 Re against Global Currencies 380 India Forex Reserves 354
125.00 360
120.00 USD GBP EURO YEN 340 28%
115.00 320
110.00 300 321
105.00 280 315
100.00 260
95.00 240 275
90.00 246
85.00 Jul-15
80.00 Feb-15
Sep-14
Apr-14
Nov-13
Jun-13
Jan-13
Aug-12
Mar-12
Oct-11
May-11
Dec-10
Jul-10
Feb-10
Sep-09
Apr-09
Nov-08
Jun-08
Jan-08

Aug-15
Jul-15
Jun-15
May-15
Apr-15
Mar-15
Feb-15
Jan-15
Dec-14
Nov-14
Oct-14
Sep-14
Aug-14
Jul-14
Jun-14
May-14
Apr-14
Mar-14
Feb-14
Jan-14

• Post the QE3 tantrum of 2013:

• RBI has increased its forex reserves by more than US$ 79 bn. Up by approx 28%

• In similar duration when RBI was increasing its Forex reserves, the Rupee still managed
to rally against most currencies. Re only marginally declined against the US$

• We believe that Rupee is relatively strong vis-à-vis other currencies. Additional US$ 79 bn
buffer is also a cushion to stem any forex volatility from impending US rate hike

Historical Performance of 10 yr gilt 23.4 Performance Stats
with 1 year horizon

28.77%

19.34% 20.28%

12.74% 14.62%

8.3

4.25%

returns returns returns returns returns returns Maximum Minimum Average
above 10% between between between between below 0%
5% to 2% 2% to 0%
10% to 8% 8% to 5% -2.2

• An investor for a negative downside risk of 4%, has obtained more than 10% returns
around 28% of times

• The maximum risk-return trade off is skewed in favor of positive returns since upside is
more and down side is less.

Assumption : The investment is made in 10 year gilt is between the 7.8% to
7.9% band with 1 year investment horizon

Historical Performance of 10 yr gilt
with 1 year horizon

59.39% Performance Stats(in CAGR %)
20.00%
10.72
7.94

5.63

9.70% 10.91%

0.00%

Above 10% between between 8% between 7% below 5% Maxium Minimum Average
Return Return Return

10% to 8% to 7% to 5%

• An investor had no negative performance risk. The possibility of more than 10% returns

was around 10% of times

• The risk-return trade off is skewed in favor of positive returns since upside is more and
down side does not exist.

• An investor within (or approaching) the Long Term Capital Gains ambit is recommended
to stay invested given the strong fundamentals, rather than lose the high potential gains
possibility and the tax mitigating opportunity by exiting now.

Assumption : The investment is made in 10 year gilt is between the 7.8% to
7.9% band with 3 year investment horizon

Perspective Slide Titles Message involved

Slide Number

Slide 2 Factors Affecting the Bond Market Gave the overall view on
Slide 3 factors involved in the market
CPI INFLATION OUTLOOK: TO HEAD
BELOW 5% Establishes the improving
inflation conditions

Slide 4,5,6 Agri-Supply Outlook –Normal Monsoon; Highlights the declining risk of
Comfortable Minimum Support Price; Agri- food inflation
Supply Outlook - Upsurge in Sowing

Slide 7,8,9,10 Gilt Supply Side Improvement; Demand Shows the demand tilt in
Slide 11 Supply Equation; Long Term G Sec Demand; towards the demand supply
Expected FII Limit increase equation

Foreign Exchange Fundamentals Provides a view of strong
foreign exchange
fundamentals

Slide 12,13 Investment Potential in Long Duration(1 yr & Provides a view of the risk-
3 yr horizon) return trade off for investment
in long duration

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MARKET OUTLOOK

Long Term Rates: Data Driven

• RBI decided to hold the key policy rates in its 4th August policy meet
• They are waiting for additional data on CPI, monsoon, rate transmission of the earlier rate cuts, and
the impact of US Fed action.
• Data inputs are encouraging and may open room for further easing of rates. we expect at least a
25bps rate cut in CY15

• As RBI is working with a 4% long term inflation target in mind, we believe it will create further room for
gradual easing over a period of 2 years.

• While US Fed rate hike is the key event, normally progressing monsoon is an encouraging sign for
monetary easing.

• The 10-year is expected to trade in a range of 7.70-7.90%
• The increase in the FII limits is imminent. This will act as a positive catalyst and the yields will trend

towards 7.50%
• RBI’s overall assessment of future outlook suggests accommodative policy ahead

Short Term Rates: Positive

RBI will ensure adequate liquidity to maintain overnight rates around repo rate
Short term rates to remain in range at around current levels
Easy liquidity and expectation of no rate cut immediately have resulted in steep short-term yield curve. Short term
rate curve may flatten on the expectation of rate cut

Kotak Duration Portfolio View

Given the strong and improving macro-economic fundamental, we continue to
maintain a bullish view on the rate cuts.
• The knee-jerk sell-off post the 2nd June Policy provided us a suitable

opportunity to acquire undervalued and oversold Gilt.
• Ever since then, the market yields have resumed downward trend on month on

month basis
• Since the spreads have compressed further, the risk-return trade off has made it

prudent for us to sell illiquid assets and acquire more liquid sovereign assets.
• Anticipating a rally in gilt sooner or later we have increased the gilt duration.
• Kotak Bond and Kotak Gilt have the potential to outperform most of the fixed

income asset classes in a falling rate scenario.
• Accrual portfolios continue to remain an all season investment play. Such investors

who seek low volatility and relatively stable income may invest in these funds.

KEY RECOMMENDATIONS

Segment Scheme Rationale

Accrual Kotak Income Opportunities Fund / Investment for
Play

Kotak Medium Term Fund higher accrual

Duration Play Kotak Mahindra Bond Scheme / Investment for
Kotak Mahindra Gilt Scheme longer maturities

Short Term Parking Kotak Treasury Advantage Fund Higher post tax
of Funds return
Kotak Equity Arbitrage Fund

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DISCLAIMERS & RISK FACTORS

The information contained in this (document) is extracted from different public
sources. All reasonable care has been taken to ensure that the information
contained herein is not misleading or untrue at the time of publication. This is for the
information of the person to whom it is provided without any liability whatsoever on
the part of Kotak Mahindra Asset Management Co Ltd or any associated companies
or any employee thereof.We are not soliciting any action based on this material and
is for general information only. Mutual Fund investments are subject to market
risks, read all scheme related documents carefully.

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