The Indian stock markets have been on a heady upswing throughout September and October.

Sadly,
domestic investors and institutional investors have not been able to participate as they haven’t had too
much by way of inflows. But most of the frontline mutual funds, hit all time high NAVs much before the
stock market itself reflected an upsurge.

Does that mean that fund houses are positive the market upswing would continue? In an interview with
CNBC-TV18's Udayan Mukherjee, Prashant Jain of HDFC Mutual Fund said the market indices this time
around were fairly valued as compared to the high PE multiples three years ago when the markets last hit
20,000. “I don’t think the index valuations are stretched, it is certainly true that index is not cheap but I
don’t think it is stretched at a broader level. I think we are as close to fair value as one can be,” he said.

Jain added that a global crisis right now should not cause the Indian markets to correct too deeply. The
only negative that could see the Indian market spiral would be a spike in oil prices he said.

Here is a verbatim transcript of the interview.

Q: All your NAV’s for equity products are at all time highs, do you think the market deserves to be
at an all time high?

A: I think so, to put things in perspective last time the index crossed 20,000 was in December 2007 and
it’s almost 3 years since then and lot of growth has taken place in these 3 years. The economy is doing
fairly well. The companies are doing quite well so the PE multiples have moderated significantly
compared to last time the index was at 20,000. So I would say the index is fairly valued at these levels.

Q: Are you comfortable with valuations for the index or do you think it is stretched?

A: I don’t think the index valuations are stretched, it is certainly true that index is not cheap but I don’t
think it is stretched at a broader level. I think we are as close to fair value as one can be.

Q: Any apprehension that earnings might start to fall off over the next year or two which might
make the market look expensive in hindsight?

A: We may be disappointed or may be surprised big time by the global cyclicals but that is a function of
how global commodity prices move. If you look at the non cyclical sectors, may be consumer stocks are a
little expensive but then given the quality and sustainability of businesses I think it would still make sense
to hold on to them with 2 – 3 year view but other than that I don’t really see much excesses in the market
place.

Q: Has it been a difficult market to be a fund manager in; given the kind of very polarised
performances that you had between sectors?
A: This time around, at least at our company, the experience has been much better and we have faired
better than in 2007. I think unlike 2007, the markets have been clearly respecting quality and cash flows
in the last two years and that is what suits our style and therefore its been a good market.

Q: So you think stocks prices have actually moved in sync with fundamentals much more than the
last time we went to 20,000?

A: I think so yes, definitely.

Q: So the sectors that have underperformed deserve to be underperformers?

A: I would say so.

Q: Do you find pockets of very frothy valuations in any part of the index in any of the sectors?

A: No, we don’t find very frothy valuations at this point of time anywhere.

Q: For the cyclical sectors any sense that any of the cyclical sectors are approaching their peak in
terms of earnings?

A: That is very hard to say because we don’t know where the cycle is going but if you look at cyclicals
compared to the replacement costs, I do not think there is any great value because most stocks are
trading at reasonable premiums to replacement costs but that can happen in cyclicals for fairly long
periods of time if the cycle keeps on improving and we don’t know which way we are going and that’s why
we are basically underweight cyclicals and we also feel that if you look at some other sectors like banks
particularly the public sector banks, if you compare them with cyclicals, the risk reward is significantly in
favour of the PSU banks. Not only are the valuations much cheaper but the growth is also more secular,
acyclical and much higher and therefore we continue to prefer these over the cyclicals.

Q: So you are actually underweight on names like autos?

A: I don’t think auto is a cyclical in the strict sense, so we are not underweight autos. The volume of
growth in this segment should be very good so we have reasonable exposure. What I meant by cyclicals
are sectors like refining, petrochemical, metals and even cement we think is a domestic cyclical.

Q: And global metals?

A: We are underweight global metals, petrochemical, refining and all that.

Q: There is no Reliance in your top 5 in any of the funds so that is an under weight position?
A: It’s a big underweight; basically we think if you compare RIL with other companies you get much better
value in other companies

Q: How long has this underweight position been there in your funds?

A: For the last one year or so.

Q: What is going on with flows? Are you also seeing skittishness in part of the Retail or the HNI
investor?

A: Yes, in fact as an industry we have been seeing significant outflows though we have been fortunate, as
we are seeing significant inflows over the last one year. At a broad level, a lot of money came into funds 3
years back when the Sensex hit 20,000. That money suddenly became half or lost 40% in value and all of
it was not long-term money, it was driven by momentum by spate of IPOs, from mutual funds, etc. I think
it was feeling trapped; that my Rs 10 has become Rs 5-6. Now that the NAVs have crossed those highs
and you are also getting some reasonable return, I think it is natural to expect some redemptions at times
like these. Unfortunately though, the retail investor is 1-2 steps behind the market. So they did not invest
big time when the market was at 3K, 5K, six seven years back. A bulk of the money came in above the
18,000 index three years back and again now we are seeing redemptions. I think it’s a cycle which
repeats every few years. But I think these outflows will stop at one point of time when investors out there
feel 20,000 this time is not an excess like it was three years back. So I think at some stage this will stop
and we should be getting net inflows but it may take few months.

Q: What will convince them you think - a prolonged period of the market staying above 20,000 or a
dash away from these levels, what do you think gets them back in again?

A: I think it could be either of these two things if markets break decisively away from 20,000, then majority
should get convinced that 20,000 may become the base. Or if markets remain around these levels for
some more periods of time, I would say maybe few months. We have seen similar investor behaviour
even in the past when after a dip whenever market bounces back, at close to earlier peaks, you will see
reasonable redemptions but that stops over time and you start getting new inflows over time once again.

Q: Did you see it post the technology meltdown when the market bounced back after that, was
there selling after that?

A: Yes but the fund sizes were much smaller than the industry was small but yes it did happen.
Q: So you think in the next six months there is a chance that retail and HNI comes back to
equities?

A: Yes, I would strongly think so.

Q: So you do think a possibility of a major correction is not looming ahead?

A: This is what we have been saying for almost a year that this index is very different from the index of 2-
3 years back and corrections if any should be small and not very deep. Therefore we have been telling
clients for last many months that if markets have to fall they should fall maybe by December or by March.
Because beyond that there is not much room for markets to fall because one year from today we will be
focused on FY13 earnings and markets look fairly reasonably valued on those levels. So we have been
saying that whatever you need to invest, get invested in 3-6 months.

Q: So what could be the trigger for any fall between now and March in your eyes?

A: If you look at it structurally India has one key risk and that is the oil prices. If they spike up big time,
then that is negative for us and that may also spoil the sentiment for foreigners and they may say I don’t
want to buy now, I will time it better because India is vulnerable to oil, that could be one.

Second, it could be that global equities just come off sharply. We have seen a reasonable co-relation over
very short-term returns. But if markets were to fall only driven by global fall in equities, I would say that
would be a great opportunity to buy Indian equities once again.

Q: But in the event of a global correction do you see a more than 10-15% fall in India stock prices?

A: It would be very hard in my opinion. Because this time the crisis is unlikely to take the banks or the
governments by surprise as everyone is on their guard. So I would be surprised if a crisis of that
magnitude takes place and even if there is a correction in equities, I don’t think correction here will be
very deep.

We cannot ignore the fact that 3 years is a reasonably long time and markets are basically trading 16-17
times one year forward earnings. For an economy which is growing as fast as ours and on a fairly
sustainable basis because neither the companies nor the households are leveraged in India. It is a fairly
acyclical growth, I don’t think we are really too expensive. And given the fact that India is emerging for the
right reasons a key asset, very favoured asset globally, I think corrections would be used as better entry
points by lots of people.
Q: You think a 20% kind of earnings growth over the next two years CAGR is a reasonable
expectation?

A: One should always segregate the cyclicals and the acyclicals. If you remove the cyclicals I think it is
doable, though in some sectors we see margins at levels which are significantly higher than the historic
levels and only time will tell whether those margins revert back to normal levels or not.

Q: Give me an example which sector could you be talking about?

A: Lets say some companies in the consumer sector or some companies in the two wheeler space are
sitting on margins which are way above the historical averages. No doubt their competitive position is
very strong, underlying demand trends are very strong but you still cannot be sure that these margins will
hold for let say 1 – 2 years, but I would say 15% to 20% earnings growth minus the cyclical’s appears to
be broadly sustainable in my opinion.

Q: Do you worry about excessive dilution by any of the companies at this point where capital is
quite abundant, which might later on pose a challenge to earnings per share growth or even
return ratios?

A: This is very sector specific, so we are not seeing excessive dilution from consumer, media,
Pharmaceuticals, Automobiles, engineering companies, or software companies. We are seeing a dilution
from a lot of real estate companies, NBFC’s and I would say infrastructure owners but that is more or less
for the right reasons. These are capital intensive businesses and if this economy has to grow at such a
brisk pace and our capacity utilization in manufacturing is also running at very high levels. So capex cycle
has to pick up. So capital will be raised.

Q: What’s your call as a fund manger on Infra, that’s underperformed and it’s a big sector. You are
a longer term investor, a value investor. 2 – 3 years can you take a big bet or just the risk of
underperformance lie there?

A: Infra is a very I would say, a very loosely used word. For infrastructure development you need banks to
fund, you need the engineering, the construction companies to build and you need the asset owners who
will ultimately own the assets. We think the banks are the best way to play this and the second best today
would be the engineering and the construction companies. The growth rates should be more or less
similar but banks stand out because they are trading quite cheap even today I would say.
Q: I can see a lot of banks in most of your equity funds top holdings but there is no L&T, it’s a
large cap, typically you would expect to see if you are bullish on infra but you have stayed away?

A: It’s a great company and the gap between L&T and number two is very large, it is just that it is quite
expensive. We own L&T but it is not there in the top 5 – 10 I would say.

Q: You don’t like the capital goods space, the BHEL’s and ABB’s of the world?

A: I think that space is good and it is just that they are expensive and I think the thermal capacity addition
in the country will peak out in the next one to three years so if you take a long term view we feel that
some of these companies might be hitting peak earnings in the next to 1 – 3 years so that’s why we don’t
own them.

Q: You have got a lot of oil in your portfolio, even the oil marketing companies, I see BPCL, HPCL
in the top 5 is that post the moves from the government and reform based or generally you think
now earnings will show up over the next two years?

A: Intrinsically if you look at replacement cost, if you look at book value, if you look at the entry barriers to
this business, I think these businesses are significantly undervalued. The challenge is whether they will
earn a reasonable return on these assets or not. I would say government policy direction is fairly clear,
they have said that for Diesel the intent is to decontrol.

I think the risk is therefore not so much government policy as it is the crude prices. If crude prices spike
up the ability for decontrol will be limited, unlikely to happen. If crude remains rangebound or falls I think it
will happen over time may be 6 months, maybe 1 year or 2 years. This sector’s profitability has to improve
because you need refineries in all parts of this country to service it effectively, you need pipelines,
tankages depots to service and these companies have that and today their technology is at par with the
most modern; they have used these last 4 – 5 years to bridge the gaps in distribution and therefore we
think as and when this sector is decontrolled the profitability of this sector will be meaningfully higher than
what we have seen in last 4 – 5 years.

Yes, there is a risk of crude prices going up but in a portfolio context 3% - 4% in a portfolio it makes
sense and that should add value over time, in my opinion.

Q: Even from here because some of these stocks have doubled ever since the petrol deregulation
came in?
A: I would think so but if you look at last ten years they are where they were ten years back and in ten
years their book value is a grown and some of these companies have reasonable sum of parts. If you
look at BPCL or some of these companies they have reasonable value which is residing there in either
offshore discoveries or strategic investments and few other companies in that sector.

Q: But it’s not just downstream, you have taken a bet on upstream as well, ONGC is there in
practically all your portfolio?

A: I think ONGC is reasonably – I would not say it will double over two years or three years but I think
related to the index it offers good value and we think overtime ONGC will also have their share of
discoveries and which should also kind of add value to ONGC.

Q: In HDFC equity fund the interesting one is Bharti. Has it been a longstanding holding or
recently inclusion?

A: No, in fact we bought it over the last few quarters.

Q: Do you think the worst is over for telecom?

A: I think so but I am not very confident about that but I think so because now almost every player is
bleeding and their network rollouts are getting lesser and the economic case for new entrants is very
weak and Bharti and few other players have come out much stronger in terms of competitive position. So
over time the worst seems to be behind us.

Q: Do you think consumption plays still have value or do you think the space is over researched
and even expensive, you own stocks like Titan, Raymond which are consumption plays. Have they
been fully priced in by the market?

A: If you look at earnings today I think so but some of these companies have great brands, they have
great growth potential ahead of them. So yes, if you look at trailing multiples for current year some of
them would be fully valued and I said that some of the consumer companies are looking fully valued but
these are businesses, some of which can grow at a fairly brisk pace with great competitive advantages for
three-five-ten years and therefore I think one would still like to hold on to them.

Q: How much of FY2012 is priced in by the market already you think?

A: Let’s look at like this, one year from today when you would be looking at FY13 the PE multiples based
on FY13 are maybe 13-14 times which is not very demanding.

Q: Assuming a constant earnings trajectory?

A: Yes, there is an assumption there but I think all of us will agree that this economy will grow north of
8%, industry and service will grow maybe 9-10% in real terms, add 5-7% in inflation so 15-17% earnings
growth is there and so I think if you have to invest with one year view – think of what the markets will look
like after one year and for that you have to price in FY13. Equities are very forward looking assets so I
think it always make sense to think not just one year but two years forward and that is where you are
more likely to take the right decision

Q: So if today you are sitting at two year forward, 13 times FY13 so by next year this time you
could be looking at that 13-17 kind of a leap which could be a return?

A: It is possible. That is what in our view that the next big move should be on the way up and not on the
way down unless something completely unexpected happens globally or if crude goes to 110-120 per bbl
and that uncertainty will always be there in equities; we cannot forecast equities over short periods, that’s
why. We can build scenarios, but we cannot say which scenario will play out. Logically the next big move
however, should be on the way up not on the way down. No bull market has peaked out at 16-17 PE
multiples. If you look historically in any bull market whenever there has been a major correction after that,
the PE multiples have been north of 25 times.

Q: You think we will get there in this run as well at some point?

A: At some point one should get there because the more the market goes up the more the money you
tend to attract and at some point it will repeat. We don’t know whether it will happen today or after three
years or more. There is one more thought if you look historically whichever economy has grown at
significantly higher than global averages tends to become very popular asset globally whether it was
Japan in 80s or south East Asia in 90s, I think that way India could acquire similar status sometime over
the next few years and if that happens, the PE multiples could go much higher. I am not saying one
should invest with that basis or premise but possibility of that cannot be ruled out. So if that happens it
would be a great exit and equities may give you much more than what one is budgeting for but I think it
would help to keep the possibility, the presence of that possibility at the back of your mind.
DISCLAIMER: The views expressed Mr. Prashant Jain, Executive Director & Chief Investment Officer of
HDFC Asset Management Company Limited (HDFC AMC), constitutes the author’s views as of this date
and is based upon information that is considered reliable, but does not represent that it is accurate or
complete, and it should not be relied upon as such. The response to the questionnaire is for information
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information / data herein alone is not sufficient and shouldn’t be used for the development or
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The statements contained herein may include statements of future expectations and other forward-
looking statements that are based on the authors views and assumptions and involve known and
unknown risks and uncertainties that could cause actual results, performance or events to differ materially
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