INDIA

MARCHING

Towards Full Prosperity

2012

WHITE PAPER PRESENTED BY MAHLER INDIA GROWTH FUND

Mahler Fund Management B.V. P.O.Box 75801 1118 ZZ Amsterdam The Netherlands Tel: 023-6200027 Email: [email protected]

Table of Contents The Myth of Volatility in Emerging Markets ............................................................ 2 Global Markets Review ..................................................................................................... 3 Global Markets Outlook .................................................................................................... 7 India- Equity Market Outlook 2012 ............................................................................. 9 India- Fixed Income Market Outlook.........................................................................12 Portfolio Recommendation ............................................................................................15

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The Myth of Volatility in Emerging Markets Volatility has been explained as a fluctuation in the investment market. This concept refers to fast changes in politics, prices, social developments, poor governance and currency fluctuations. Accordingly, for centuries emerging markets are generally considered to be volatile by Western economists. On the other hand, most of the problems like fraud in banks, political crisis in the EU, downgrades of strong firms are typically “Western” phenomenon: so where is the volatility? Although the public was informed continuously about this EM volatility, the large US firms made good profits investing there. Nowadays the concept of risk has dominated the investment paradigms whereby we still view Emerging Market investments as volatile not realising that the fluctuations in especially Japan, China and India are partly due to the volatility in Europe and the US. In the meantime history has taught us that a European state bond is more volatile nowadays than an Asian bond. The whole world has been dominated and packed with fear because of the state or sovereign crisis in the European Union following the issues in the US has shown its volatility since 2007. Western analyst’ remarks tell us more about how economists and analysts from developed markets look at China, India or other emerging markets than about the real economic situation in these countries. Emerging markets are dominated by two types of companies: state owned firms and family owned firms. Each emerging market is dominated by one or the other and sometimes both. India is hardly unique. For instance, Carlos Slim’s empire accounts for more than a third of the Mexican stock market. Even in Israel the market is controlled by a few oligarchs. Unlike the EU, India survived the crisis because of its diversity in businesses and internal control mechanisms. India is less dependent (20% of GDP) on exports compared to China or Brazil. In contrast to the other BRICs, India is the model of diversification. The top five companies make up only 23% of the market. A large portion of the economy is either state owned or family owned like Reliance (Ambani) and Tata Group (Tata). We therefore believe that volatility has become the universal phenomenon in every capital market due to the globalization and the easiness of international capital flows. Investors will soon realize that there is no safe haven anymore in the current changing environment. The volatility indeed will be the critical issue for long term investors; however, it should not be regarded as the reason to avoid emerging market investments. “Emerging markets Offer Safety — If You Diversify.” – Indicated by Mark Mobius, the diversification will be addressed as the best strategy under the circumstance.

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Global Market Review Global Market Review 

2011

If we recalled, things were fairly bright in most markets during the first half of 2011 and equities were on a roll. However, the fairy tale didn’t last long; global stock markets went down dramatically after the US losing its triple-A credit rating. The MSCI World Index declined 7.16%. Euro-zone debt crisis and inability of the US deficit “Super Committee” to agree on deficit-reduction plans led to a disappointed market performance in 2011. Nevertheless, the global market in general revised slightly in Q4 2011; most indices generated positive gains. Overall, S&P 500 reached the break-even point in the end of 2011, while Nikkei 225 fell down 17.34% to become the worst performers all over the world due to the negative impact of strong Yen on export.



1Q 2012 Mid-quarter

The vigor rebound in India stock market year to date again indicated the cyclical character of current capital market. MSCI World Index has jumped 10.31% and totally recovered the loss of the entire year of 2011. U.S and Europe has more significant upward movement; while momentums in Asia and Australia markets are relatively weak. It is indicated that, instead of the improvement of economic fundamentals, the return of investors risk appetite and higher liquidities in the global capital markets.

Global Stock Market Performance (As of 29/02/2012) Country (Index)

Value as of 29/02/2012

Y 2011 Returns (%)

YTD Returns (%)

Worldwide (MSCI World)

1304.48

-7.16

10.31

USA (S&P500)

1374.09

0.00

9.26

Europe (MSCI Europe)

1401.74

-13.82

11.64

Japan (Nikkei 225)

9777.03

-17.34

15.63

Australia (ASX200)

4273.105

-15.18

5.34

97.2

-17.31

12.39

Asia Pacific (MSCI Asia Pacific)

Emerging Markets Review



2011

2011 was also a tough year for emerging markets: Global equity funds saw a new outflow of US$160.1 billion in 2011, including US$47.8 billion leaving emerging market equities (EPFR Global, 2011). Among all EM countries, the Egypt stock market went off 42.49% as the worst performer due to the political P.O. Box 75801 | 1118 ZZ | Amsterdam | +31 23 5563240 | [email protected] |www.mahlerfunds.com Chamber of Commerce Amsterdam No. 53020991 3

uncertainty; meanwhile, Indonesia climbed up significantly at Q4 2011 and gained 3.20% in the end of 2011. If we solely focus on three months returns, the high volatility of emerging markets actually brought more opportunities for investors than developed economics. Asian-Pacific markets in general had better performance came along with the signal that the inflationary pressure started softening or remained flat.



1Q 2012 Mid-quarter

Like most developed economics, emerging markets have well again during the past two months. The indices even enjoyed stronger momentums due to the smaller market capitalizations. The most obvious example is Egypt Stock market has surged 48.24% within two months, which compensated the loss of 42.49% last year. This phenomenon shows that nowadays when the economic went through the bottom and be ready to rebound, emerging markets will be the start point of the cycle.

Emerging market Indices (As of 29/02/2012) Country / Region Brazil (IBOV) China (SHI) Hong Kong (HSI) India (SENSEX) Russia (RTSI$) Australia (ASX200) Indonesia (JCI) Thailand (SETI) Malaysia (FTSE Bursa Malaysia) Korea (KOSDAQ) Taiwan (TWSE) Turkey (ISE NATIONAL 100) Egypt (EHI) South Africa (JSE TOP 40) Dubai (DFMGI)

Value as of 29/02/2012 67111.02 2460.6929 21562.26 17636.8 1726.79 4273.105 4004.868 1165.15 1583.78 543.97 7845.77 60958.27 5369.97 30401.12 1702.01

Y 2011 Returns (%) YTD Returns (%) -18.11 17.72 -21.68 11.88 -19.97 16.97 -24.64 14.12 -21.94 24.73 -15.18 5.34 3.20 4.78 -0.72 13.64 0.78 3.46 -10.98 8.75 -21.18 1.89 -22.33 18.45 -42.49 48.24 -0.59 7.22 -17.00 25.76

Non-EM regions Market Review



2011

For the US stock market, 2011 was a long wild ride to nowhere. S&P 500 endured huge daily swings but a year of drama left the index almost where it started. However, European shares fared much worse than the US after the Euro zone sovereign debt crisis exploded in August. Out of the heavily indebted PIIGS

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(Portugal, Ireland, Italy, Greece and Spain) countries, Irish shares fared best and surprisingly rose 0.58% to the end of 2011. The uncertainty surrounding the Euro became one of the main culprits for 2011’s losses. Britain’s top share index, which fortunately suffered relatively lower impact from euro, enjoyed a late rally in December; the FTSE 100 in 2011 closed to up 0.1% after a year.



1Q 2012 Mid-quarter

Predictably, US capital markets have better performance than Europe markets in terms of the year to date returns. Although there are some positives for Greek crisis solutions, the damage of European economic is not expected to be diminished in the near term. Nevertheless, there has been evidence of a recovery in sentiment, with the risk appetite indicators back into positive territory.

US & EU market Indices (As of 29/02/2012) Country / Region US-S&P500 US- DOW JONES US-NASDAQ UK (FTSE 100) France (CAC 40) Germany (DAX) Hungary (BSEI) Austria (ATX) Poland (WSE WIG) Czech Republic (PSE) Sweden (OMX STOCKHOLM 30) Finland (OMX Helsinki Index) Norway (OBX) Greece (ACS) Italy (FTSE Italia AS) Luxembourg (LLI) Netherlands (AEX) Iceland (OMX) Denmark (OMX 20) Switzerland (SMI) Spain (Spain MA Madrid) Portugal (PSI) Ireland (IOI)

Value as of 29/02/2012 Y 2011 Returns (%) YTD Returns (%) 1371.66 0.00 9.26 5.53 12962.44 6.24 -1.80 2991 13.89 0.10 5931.25 6.44 -16.95 3501.61 10.76 -14.69 6921.8 17.69 19221.87 -20.41 13.27 2224.73 -34.87 17.91 41612.76 -20.83 10.47 1018.3 -25.61 11.76 1104.31 -14.51 11.53 6168.93 -30.11 14.65 314.76 -10.69 10.72 748.57 -51.88 9.91 17897.66 -24.29 12.39 1253.40 -26.39 9.75 327.46 -11.87 4.50 1110.72 2.03 7.90 457.58 -14.78 17.21 6133.95 -7.77 3.23 861.13 -14.55 0.38 5655.67 -20.37 2.54 3248.73 0.58 11.61

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Global Markets Outlook 2012 North America The US stock market ended up almost as the same level as it began in 2011 but still outperformed most major stock markets all over the world. Meanwhile, strong corporate earnings have made stocks relatively attractive: The Earnings-bond yield gap suggests that equities, compare to bonds, are very attractive with current risk premium well about their long-term averages. Most of US leading indicators are still weak but numbers are promising: Unemployment rate in November 2011 fell to 8.6% from 9% in October 2011, the consumer confidence also spiked to 64.5 in December 2011, up from the downward-revised 55.2 in November 2011. In a nutshell, we are neutral about the US stock market performance in 2012 since the weak fundamentals are not expected to be improved significantly; however, the cheap valuations imply the value of long term investments.

Europe European stock markets are in general the worst performing category in 2011. The Euro crisis has been one of the main themes of 2011 and, needless to say, it is likely to be one of the leading stories for 2012 as well mainly due to the lack of decisive political leadership. Until a lasting solution is developed, we believe that uncertainty and fear will continue to dominate asset allocation to European equities and therefore the market volatility will be still to remain high. Looking forward, we suspect the ECB will play the most important role in affecting European financial market performance in 2012. The ECB in December 2011 actually took aggressive and proactive action to both ease funding constraints on banks and reduce the risk of bank failure through its innovative issuance of unlimited 3 year loans. We expect ECB might be able to cut interest rate sharply to 0.5% in 2012 to further reduce the stresses of European financial system.

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Emerging Market 2011 is also a turbulent year for most emerging financial markets. Nevertheless, emerging economics in general will face less of the threat from inflation and the capital inflows are expected to be stabilizing. We suggest overweighting emerging markets since the growth momentums and cheap valuations in local markets still provide higher possibility of capital returns. In terms of geographic areas, we expect that the South American economies will continue be decelerated by the external global recession. Good news is Brazil’s inflation had cooled down further in November 2011 and we expect a more accommodative monetary policy from its central bank. The improvement of US

Source: National Bureau Of Statistics of China, Bloomberg consensus forecasts, J.P. Morgan

economic data will also benefit Latin America generally, specifically Mexico. Most of economic figures in China have been slowed down in Dec.11’, indicated the concern of sluggish economic growth and the possibility of hard landing of the largest economic over the world. While India also suffers from the declined economic downwards, however, the inflation has eased slightly from Q4 11’and might have the chance to meet India’s central bank’s comfort level in the coming months.

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India- Equity Market Outlook 2012 India stock Market remained volatile in 2011 The volatility of India stock market, high interest rates along with devaluation problems resulted in the negative returns of SENSEX in the end of 2011. Sector indices were almost all ended in red except for FMCG sector, which had been outperformed since last quarter. From the fundamental perspective, India’s third quarter 2011 GDP growth decreased to 6.9% YOY from 7.7% the previous quarter due to the slump in manufacturing. On the top of that, the large depreciation of INR, 16% in 2011, shows the negative signals of widening trade deficit and weak capital inflows from European banks. Without doubt, the global uncertainties present challenges for India, that will continue in 2012; however, the good news is that historically India has tend to reform systematically in periods of crisis and therefore the stock market might have better chance to rebound this year. We believe the INR will appreciate in 2011 following the inward investment in India’s infrastructure and the falling of inflation during recent months. Once international investors are able to relieve their concerns about inflation, there will be a revival in sentiment and that should bring more inflow, resulting to the rally of the Rupee. The INR will strengthen 4% to 51 per dollar by the end of 2012, according to ING Vysya Bank Ltd. The downside risk will still come from India’s current account deficit and rising oil prices, which contributed to the INR’s 2011 slide.

BSE’s Index performance

SENSEX Sector performance

(As at the end of Dec. 2011)

(As at the end of Dec. 2011) -16 -16

-51 -47 -47 -39 -60 Source: BSE, Bloomberg

Tech IT -16 Consumer Durables Realty Consumer Gods Metals FMCG Oil & Gas -29 Power Banks -31

-40

-20

10

0

20

% weights of SENSEX Index

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Inflation has cooled down sharply Another relief comes from the ease of the concern of high inflation in India. Food prices, which have a weighting of about 14% in the nation’s inflation basket, has come off significantly since October, 2011. CPI also moderated to 9.34% in November from 9.39% in October, 2011; and we expect it has high possibility to fall to below 8% for December, 2011. Therefore, the inflation has started showing a downward momentum. It will be helpful for further policy stance be guided by the balance between inflation and economic growth.

Low impact of Euro crisis on India Europe’s never-ending drama does not look like it will be resolved quickly. For India, however, the impact is relatively low since the GIIPS (Greece, Ireland, Italy, Portugal and Spain) are not the major import and direct investment countries for India: GIIPS account for only 3.7% of India exports and it account for less than 1% of FDI inflows in India. On the top of that, Indian banks’ exposure to GIIPS amounts to around USD 1 billion and hence the risk is relatively low.

Sector opportunities for growths Looking in depth to sectors, we expect significant growth in particular five industries based on the economic structure, the government favored policy along with the components of India SENSEX index: the financial service, domestic consumption, agriculture, infrastructure and family owned business. The soaring demand for financial service is attracting increasing foreign investment to India. Currently, India has around 100 private, public and foreign-owned banks. At 10% or more, average return on equity (RoE) among these leading institutions is higher than many other emerging Asian markets. It is indicated that the positive policy and the competitive demands for enhanced financial service products are creating further openings for multinational financial groups in the near future. As the kingdom of agriculture, India has the second world‘s largest agricultural sector; it represents over 20% of India’s GDP and 50% of employment. We consider the surging demands from urbanization and sustainable investment inflow will enhance the potential growth of agriculture in India.

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Looking forward, Indian domestic consumption is estimated to be the next mainstream with the rapid expansion of massive retail chains. The opportunity to develop retailing on a very large scale exists mainly in the domain of food and household products. The next favored industry followed by consumption will be the infrastructure sector. Infrastructure investment is expected to surge to 12.1% of GDP by FY20 from estimated 7.0% of GDP in FY11. Moreover, the share of the private sector in infrastructure financing gradually increased from 25.1% in FY05 to 32.7% in FY10 and is expected to increase further to 45.2% in FY20. Finally, as we addressed in the beginning, the majority of companies in India are family-owned business. The market cap of FoB in Indian market in 2011 approaches to 60% and these small and medium entrepreneurs business (SME) contribute more than 20% to India’s GDP. The Indian economy is close to the bottom of its inflationary phase and expected to be able maintaining the growth rate around 7%. FoB will continue to be the core fundamentals to underpin the economy.

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Positive building up in 2012 Several new policy regulations and economic data are expected to bring positive signals to the market in 2012. First, the permission for QFI’s to invest directly in equity markets is officially implemented in January 2012. Second, as we mentioned earlier, the inflationary pressure has been eased gradually and therefore the policy will be able to address more on the economic growth in 2012. Moreover, it is expected that the government will have the second push to retail FDI, new bills in power and pension funds. Looking forward, we estimate that the Indian equity markets will continue to remain volatile in the period; however, from the valuation perspective, small and mid-cap are very cheap and attractively valued. We believe the current Indian stock market environment is composed of low valuations and high investor fears. It implies a signal for long term out-performance for investors; given the fact that the market is just in the initial stage of revival without the overheat concerns. There´s a saying: “Be greedy when others are fearful; be fearful when others are greedy.” Therefore, we suggest investors who seek for long term value investment and diversified portfolio should watch Indian stock market closely in 2012 to grasp any possible investment opportunities in the right timing.

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Indian- Fixed Income Market Outlook Debt Market Review 2011 The slowdown of economic growth continued strengthen Indian bond market performance: while Indian equities have given negative returns of around 25% over 2011, intermediate and long-term government bonds have one year yield returns in excess of 4%. The yield on 10-year Government benchmark bond ended lower at 8.57% with the volume of Rs.5222.50 Cr. in December 2011. The average LAF in December 2011 was negative Rs. 101,395 Crs as compared to negative Rs. 81,384 Crs in November 2011. The food articles inflation, which counts for 14% of India’s WPI (Wholesale Price Index), touched a low of 0.42% in December 2011 end, indicating the on-setting in the growth of inflation. On the other hand, the fuel, power light inflation basked remained high by standing at 14.37% in December. The current account deficit in the third quarter 2011 widened to $16.89 billion from $15.83 billion in the second quarter 2011. In the Mid Quarter Monetary Policy Review of December 2011, RBI (Reserve Bank of India) kept policy rates unchanged with the comments that they “are likely to reverse the monetary policy cycle“. This positive announcement along with its successful OMOs (Open Market Options) to purchase government securities worth Rs.10,000 Cr due to evolving liquidity conditions propelled the downward shift of yield curve in December 2011. Snapshot of Indian Fixed Income market (as of 30th Dec. 2011) Particulars

Dec-11

Nov-11

MoM

YoY

10 YR IGB (Yield)

8.57%

8.65%

-8bps

67bps

10 YR UST (Yield)

1.89%

2.03%

-14bps

-140bps

Avg. LAF Surplus/ Deficit (Rs. Cr)

-101,395.00

-81,384.00

-20,011.00

17,785.00

Currency (Rs/$)

53.27

51.21

2.06

8.57

Foreign Reserve (Billion $)

300.8

304.4

-3.60

5.80

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Investment Opportunity in Debt market 2012 In 2011, India’s Market was volatile as investor’s sentiment was negatively impacted, which is likely to continue into 2012 and affected market performance. Looking ahead in the short term, we therefore expect equity market is likely to be more unstable whereas debt looks more attractive. However in the long term, we are bullish on equity due to its under-valuation and regard bond as part of liquidity allocation in investors ‘portfolios.

Falling Inflation: Positive but uncertain movements The drop of WPI in Nov. 11’ is the first sign that inflation easing. Both Indian government and RBI are also taking steps such as reducing import duties on foods and custom duty on crude oil to control inflation. Nevertheless, it doesn’t imply inflation will start sliding downwards right away and continue the trend permanently. The depreciation of INR against most other major currencies since July 11’ had led to higher cost of imports and therefore will bring the concern of cost-push inflation in the coming months.

Rising possibility of Monetary Policy Stance alternation We expect the inflation in India will come down in the following months and hence give RBI some room and confidence to execute interest rate cutting policy in H2 2012 after seven interest rates increase in 2011. Since Bond prices and interest rates have the inversion relation, it is reasonable to predict the rising trend of bond price as the interest rate is on downward spiral. Recalled RBI’s positive announcement in mid-December which resulted in $3.9 billion inflow of India’s bonds, the biggest increase on record, we can estimate that the system will also be able to breathe easy on liquidity if RBI starts the rate cutting policy earlier in this year.

Fiscal deficit problem still remained The Indian economy has been in the deficit mode for over five quarters owing to the combination of a high inflation, interest rates and currency depreciation. The government aims to pare its fiscal deficit to 4.6% of GDP for the fiscal year 2012, a target that seems hard to achieve with the slower growth and weak markets. To control the current account deficit, the government needs both high domestic savings and foreign investments. While the domestic saving growth was improved in Dec.11’, the foreign investment have declined sharply recently though. Hence, the future favour policies will be the key indicators to improve the situation.

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Short –Term funds and Gilt funds are rising stars Considering of the continuing volatility of bond market in 2012 and the uncertainty of global economic condition, we believe for investors who address on short term liquidity, the short term funds will be more attractive as the current yield curve is slightly inverted as liquidity improves in the system. It is estimated the yield on shorter maturity paper will decline further and give capital appreciation to their investors. Meanwhile, Gilt bond funds could be another good choice for long term investors since they invest predominantly in government securities and thereby benefit the most whenever the interest rates come down. However, short term volatility might be observed in these funds.

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Portfolio Recommendation The financial world has changed dramatically after financial crisis in 2008. Nowadays, investing in developed financial markets are not the guarantees of stable returns anymore; while emerging markets are neither necessarily the synonyms of risky investments. To diversify the portfolio, investors should take the changing economic environment into consideration and allocate their assets in different investment instruments respectively based on individual’s risk appetites.

Aggressive Portfolio

Moderate Portfolio

10%

15% 25%

20%

25%

10% 20%

20%

20%

Conservative Portfolio

20% 25%

25%

30% 15%

20%

Emerging Market Regional Stock Funds

Emerging Market Regional Stock Funds

Global Stock Funds

Global Stock Funds

EM Single Country Stock Funds

EM Single Country Stock Funds

Emerging Market Fixed Income Funds

Emerging Market Fixed Income Funds

Global Fixed Income Funds

Global Fixed Income Funds

Global Fixed Income Funds

Money Market Funds

Emerging Market Regional Stock Funds Global Stock Funds Emerging Market Fixed Income Funds

Aggressive Investor: Aim at potential growths of Emerging Markets The European debt crisis lingers on and the continuing uncertainty is affecting the regional economic growth. Hence, for investors who pursue for higher possibilities of returns, emerging markets is the spot cannot be missing in 2012. Regional EM stock funds and single EM country funds will be the ideal

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vehicles to enjoy the growth momentum of specific EM areas. We believe that India market will start to rebound in H2 2012 and therefore investors could put the related funds into basket in H1 2012. Apart from stock markets, emerging debts offers not only a diversifier role but also attractive prospects based on the higher interest rates. Foreign currency exposure might bring some volatility to the portfolio, however, the emerging currencies might also contribute positive gains considering to the downward of Euro.

Moderate Investor: Balance portfolio by weighting on EM fixed income funds For investors who have less confidence about emerging markets, we suggest to adjust the weights between global stock funds and emerging market stock funds and maintain the total stock market exposure below or equal to 50% of the portfolio. Regarding to fixed income market, High-quality government bond yields have come to the historical lowest point since 1900. In the Netherlands, the low was recently set at 2.2%, while the short rate is 2.4%. It indicates that high quality government bonds are relatively unattractive over the medium-long term due to the low interest rate policy, although they still consider as safe places for investments. Therefore, we believe that the fixed income returns can be improved by adding emerging market bond funds into portfolio instead of only investing in high quality government bond funds.

Conservative Investor: High liquidity is the priority As the high validity of global stock markets continues, risk adverse investors might find it more and more difficult to find a secure instrument or regions to invest. We suggest the primary investment principle in 2012 will be keeping the high liquidity all the time. Money market funds therefore come to play a role in the portfolio due to its liquidity feature. While single EM country stock funds are too risky to invest, the regional or general EM stock funds might be a better choice to decrease the possible risks.

NOTE: Mahler Fund Management BV (“Mahler Funds”) is providing this document to you for informational and educational purposes only. The information does not take into account your individual situation or circumstance. MAHLER FUNDS does not provide tax or legal advice. We urge all clients to consult with their own tax or legal advisors to obtain advice specific to your personal financial situation. This information is intended to provide a general overview of the topics discussed and to assist you in the review of your investment alternatives. MAHLER FUNDS has not taken any steps to ensure that the techniques referred to are suitable for any particular investor. Information and opinions expressed by us have been obtained from sources believed to be reliable. MAHLER FUNDS makes no representation as to their accuracy or completeness and MAHLER FUNDS accepts no liability for losses arising from the use of the material presented. References to legislation and other applicable laws, rules and regulations are based on information that MAHLER FUNDS obtained from publicly available sources that we believe to be reliable, but have not independently verified. You should consult with your personal legal, accounting and tax counsel to ensure the proper interpretation and application of all legislation, laws, rules and regulations, whether or not cited herein, as they apply to your personal situation. © 2011 Mahler Fund Management BV and/or its affiliates. All rights reserved.

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