Dear Reader,

I take pleasure in presenting my second newsletter. The fundamental theme

remains the same - to dive deeper into economic issues that affect our investors.

However, keeping the interests of a diversified investor base, I have tried to keep

the analysis at a macro level without getting into minute details. I am convinced

that we are looking at further strengthening of the dollar with the US current

account deficit lagging economic growth by a wide margin. As you will read, you will find out its

deflationary implications on Emerging Markets (EMs). However, having said that, I believe that India is

better prepared than many EM economies to weather any such challenges. With the Fed taper drawing

to an end and as we transition towards higher interest rates (and consequently lesser equity buybacks),

fund flows to EMs including India could be impacted.

I see the prodigal son returning – with real interest rates back in the positive zone, households are

increasingly looking at financial assets to park their savings. These are encouraging signs and one trend

reversal which I would like to see continuing. As with my previous newsletter, I have tried to present an

emerging sector equity theme: E-commerce – I know these are early days and the sector has limited

investment opportunities but I certainly like the theme and have it on my watchlist.

One final section which is being newly introduced is an interview with our fund management team - this

issue carries an interview with our senior fund manager Pradeep Gokhale who has been with the fund

since 2004. The idea is to give our investors an inside peek into the people who are managing their

money. Always best to get it straight from the horse's mouth isn't it?

Ritesh Jain

Chief Investment Officer,

Tata Asset Management Limited

CIO NewsletterOctober 2014 • Volume No. 002

Money amplifies our tendency to overreact, to swing from exuberance when things are

going well to deep depression when things go wrongNiall Ferguson

(Economist & Historian)

1. Resurgence of the dollar 3

2. Maturing global trend 4

3. Emerging Investment Trend 5

4. Emerging equities Theme: E-commerce 8

INDEXINDEX

Page No.

2

5. Meet our Fund manager 9

Growth seems to be returning to the US; it is not

particularly strong but it is structurally different.

In previous cycles, growth was accompanied by

an explosion in the current account deficit; this time the

deficit is shrinking. This has implications for the rest of the

world since the US CAD is an important driver of global

liquidity. The US CAD is now around 2% of the GDP

compared with 5% in 2007. In my view there are three

reasons for it:

1. The US shale gas revolution makes energy dependent

companies produce more cheaply in US

2. Baby boomers in US are deleveraging and saving in

preparation for retirement. The favourable demographics

that had supported consumption (and higher CAD too) up

until now seems

to be changing.

One look at the

accompanying

graph of growth

in sales of adult

d iapers over

b a b y d i a p e r s

tells you that the

c o n s u m p t i o n

pat tern in US

m i g h t b e

u n d e r g o i n g a

s t r u c t u r a l

change

3. Monthly factory wages in mainland China have tripled

since 2007 compared with a single digit increase in the US.

Developments such as robotics are reducing the

importance of cheap labour in global competitiveness

To cut the long story short, an over-indebted world in US

dollars (it is still the reserve currency of the world!) may

find the greenback becoming expensive over next few

years. There is a near consensus that US tapering will come

to an end this October and interest rates will start rising by

middle of next year. This will restrict the ability of many

emerging economies to borrow in dollars and refinance

their existing debt. With these economies having

embarked on a dollar-denominated borrowing binge to

make up for the shortfall of earned US dollars, I see some

of them being forced into deflation by the US' inability to

run sufficiently large current account deficits. I also believe

that India is better prepared to weather this storm than

most other EMs.

The rising US dollar is the best indicator of the squeeze on EMs.

I believe there is a black swan event lurking somewhere in

future, may be a Yuan devaluation - who knows? As Asians, we

are no strangers to currency devaluation during troubled

times and there is no compelling reason to suggest that this

will be the last time either.

Recommend staying away from companies and

countries having excessive dollar liabilities. Watch out

for impact on Indian exports if the Chinese were to

follow the Japanese in competitive currency

devaluation.

3

Resurgence of the Dollar

With the CAD not keeping up with growth (it hasn't moved much

since 2010), we could be possibly looking at a lurking shortage of dollars

US Current account balance (% of GDP)

Source: CLSA

Global gas price differences$US/MBtu

Well what can I say but I caught it late, in fact very

late. US corporate are falling over each other to

buy back their floating stock. Now, as our

dusted management books tell us, the primary reason to

buyback stock is to return cash to investors if there are no

good opportunities to deploy this cash to grow the

business organically or inorganically. So is that why stock

repurchases have soared even when the broad US equity

index is hitting all time highs? NAH, the buybacks are

happening with borrowed money and cash is lying

overseas for tax arbitrage!

US equity repurchases have reached pre-recession levels

with buyback in each quarter surpassing the previous

quarter. Large scale buybacks like these leave investable

cash in the hands of investors, some of which has found its

way into EMs including India. The companies in the S&P

500 index bought $500bn of their own shares in 2013,

close to the high reached in the bubble year of 2007. IBM

provides us with an excellent example. As David stockman

points out, since 2004 IBM has generated $131bn of net

income, spent $124bn buying back its own stock and

devoted $45bn to capital expenditure. IBM has therefore

been channeling almost all of its earnings into stock buy-

backs and has bought back almost $3 of its own stock for

every $1 of capex. No wonder IBM just reported declining

year over year revenue for the 9th quarter in succession.

John Rockefeller once said his sole pleasure was "to see my

dividends coming in", but buy-backs have usurped

dividends as the main way listed American firms give

money back to their owners, accounting for 60% of cash

returns last year.

Rise in US interest rates could lead to reduction in the

pace of buyback and impact flows to Emerging

Markets

Hereon, we move to an entirely different pattern and one of

very positive significance for financial markets in India.

Maturing Global Trend

Quarterly share repurchases ($ mn) and buyback yield (%)

4

Source: Citi Research

Return of the prodigal son? Channeling

household savings back into financial

instruments

I am spotting an incremental but seemingly definitive

trend in distribution of household savings within financial

and physical assets (gold & real estate). After having lost

savings to real estate and gold, financial instruments look

to provide a safer avenue to channel household savings if

recent trends are any kind of an indicator. As per RBI data,

financial savings of households have increased for the

second consecutive year in FY14 having increased faster

than nominal GDP for two consecutive years now.

However, at 7.2% of GDP in FY14, it remains well below the

FY11 level of 9.9%. Sustained positive real interest rate is

critical for the distorted savings behavior of households to

correct. With RBI moving to CPI as the primary inflation

gauge and remaining firmly focused on a sustained

moderation in inflation before cutting rates, the recent

improvement in financial savings is likely to sustain in the

medium-term.

The slump in the real estate market is also a trigger for

switch to financial instruments. There are strong grounds

for switching to financial assets; in some markets, returns

from financial assets have outdone returns from real

estate. The reduction of black money funded real estate

transactions in the economy (real estate sector is one of

the most fertile grounds for creation and deployment of

black money) will help in reducing inflationary pressure

and thereby pave way for a gradual reduction in interest

rates.

Emerging Investment Trend

5

Real estate prices are flattening out in most cities – has the migration already begun?

Advise investors to take advantage by investing for longer durations and for borrowers to go for

floating rates.

Source: NHB Residex

Source: RBI

lobal markets saw listing of the US$25 bn IPO of

Gthe Chinese Ecommerce giant Alibaba recently. It

was the biggest IPO by market value of all time,

valuing the company at nearly US$230 bn on debut,

surpassing giants like Facebook, Amazon and Ebay.

Closer home, our own domestic Ecommerce giant,

Flipkart, raised US$1 bn from investors, valuing it at over

US$7 bn. Not to be outdone, its compatriot, Snapdeal, now

counts Ratan Tata among its shareholders. Such

excitement!! What's cooking? Let's take a look.

In the last newsletter I touched upon a few themes which I

believe will outperform over the next decade. Continuing

from there, the Government's focus on 'Digital India' will

not only boost connectivity and governance, but will also

trigger a data boom giving a fillip to the 'E-commerce'

space.

Emerging Equities Theme: E-commerce

8

What is 'Digital India' ?

The plan targets connecting 250,000 villages' broadband

internet at US$5 bn cost by FY17. Further, 250,000 schools

and colleges and all Universities are planned to be Wifi

enabled. Total investment envisaged to make India 'Digital'

will be ~US$17 bn over the next 5 years.

As per estimates, nearly US$40 bn will be invested in digital

infrastructure over the next 5 years. This should give a fillip

to the Indian E-commerce space.

The E-commerce market more than doubled in 2013 to

US$2 bn. Yet, India's E-commerce market is puny as

compared to China and other BRIC countries. India is 7

years behind China in terms of Internet usage and E-

Commerce transactions.

Source: Accel Partners

Source: Accel Partners

YoY growth albeit on a small base - ~15mn handsets. Share

of smart phones to total shipments stands at ~25%

(Source : CMR India). This is likely to be 45%, or half a billion

smart phones by 2020.

India E-comm : >4x by 2016

Unfortunately, Indian investors have not been able to

directly participate in this growing opportunity so far, as

much of the early investment is seed funding by PE

players. But the logistics and the allied telecom sector is

already showing signs of indirectly benefitting from this

boom. Also, some of the brick and mortar companies too

are gearing their distribution for the online platform.

Hopefully, as business models become more robust and

visible, investors will get an opportunity to participate in

the ecommerce theme directly via public issues soon. Till

then I continue to look out for allied beneficiaries stated

above.

9

Indian e-Commerce market is $2Bn, ~50 times smaller than the Chinese market

... annual spend per Indian online shopper is $93 - 4x smaller than Chinese one

$ 2 Bn / 1x

India

$ 13 Bn / 7x

Brazil

$ 16 Bn / 8x

Russia

$ 106 Bn / 53x

China

India Brazil Russia China

$ 93

$ 421

$ 533

$ 380

600 Mn

500 Mn

400 Mn

300 Mn

200 Mn

100 Mn

0 Mn

100%

80%

70%

50%

30%

20%

0%

10%

40%

60%

90%

2013 2020

90 Mn

520 Mn

10%

45%

That India is headed the China way is clear from the smart

phone sales statistics. The Indian smart-phone segment

remains in high growth phase – Q1CY14 recorded >200%

Conclusion

While the rising dollar, better US economic growth and rising US rates could channelize US savings towards productive

real assets like factories , buildings etc , in India, falling commodity prices (which boosts purchasing power) supported by

favorable demographics will probably channelize savings away from low or non productive physical assets to financial

assets. With low representation in investor portfolios and higher prospective real rate of return, I believe that

investments in financial assets could increase manifold (and more importantly, buck the downward trend) hereon and

the next few years could be characterized by a flight of savings from physical to financial assets.

Hence our calls on interest rates and markets continue to be constructive, notwithstanding bouts of volatility

arising out of uncertain global environment. I am especially positive on the digitization trend which may cause a

paradigm change in the way much of the business is done at the consumer level and see it as a significant

earnings driver.

Source: Accel Partners

Source: Accel Partners

Source: Accel Partners

10

W i t h Ta t a A s s e t M a n a g e m e n t s i n c e :

1st September 2004

Funds Managed: Tata Equity Opportunities Fund,

Tata Ethical Fund, Tata Index Fund, Tata Pure

Equity Fund, Tata Retirement Savings Fund -

Progressive Plan, Tata Tax Saving Fund, Tata Tax

Advantage Fund -1, Tata Dual Advantage Fund

• How do you define your investment philosophy?

The core belief that forms the basis of our investment

philosophy is that superior investment performance

over a period of time comes only from fundamental

research driven stock selection. We believe the

investible universe can be divided into two broad sets :

Higher quality set of businesses – companies that have

compounding characteristics, good governance,

better management quality, innate strengths in their

business areas and superior capital efficiency.

Tactical opportunity set - Businesses having a basic

standard of quality, which may make a good purchase

Meet our Fund Manager

at a certain valuation. This is the other set of

companies that we track for trading gains.

Within these two sets, our bias is towards companies

in the first set. I prefer businesses -

• with high entry barriers or businesses that have

innate strengths that are difficult to replicate for

competition

• which are scalable and have secular growth

opportunities

• with high capital efficiencies, which is a sign that

management makes rational capital allocation

decisions.

Growth at Reasonable Price (GARP) is my preferred

investment style. Thus typically my portfolios have

companies with secular growth potential and higher

return on equity (ROE) which is normally associated

with higher P/E and P/B ratios.

• How do you judge the performance of your funds?

Any misses?

I have been successful at beating benchmarks

consistently across different market phases - bull or

bear with a decent margin. My funds have generated

excess returns with low volatility and have good long

term performance. The only missed opportunity is

that during the last six months, when valuation

differentials between cyclicals and secular growth

stocks were high, I did not increase the weight of

cyclicals.

• How do you determine your sector allocation

strategy? Do you take cash calls?

We do not take cash calls. Typical cash holdings are

between 3-5%, which is more driven by differences in

pay in and pay out dates of stocks purchased/sold on a

particular date. The sector allocation depends on the

Pradeep Gokhale,

Senior Fund Manager

11

relative attractiveness of a particular sector with

respect to earnings growth prospects and valuations.

We take significant overweight and underweight

positions with respect of benchmark weights, within

the overall limits of Internal Risk Control guidelines.

• On a micro level, what do you look for in your

company meetings/visits and how do you achieve

superior bottom-up research?

The company visits and management meetings help

provide an insight into the company's prospects. The

meetings focus on assessing the industry scenario

and size of the opportunity, competitive landscape,

management's objectives and strategies adopted by

them to achieve them, financial position and trends in

margins and cash flows. The key is to find the main

value drivers for the company and key risks that need

monitoring. We monitor how much the company has

progressed on achieving its objectives. The effort is

focused on assessing the basic earnings power of the

company which is more structural in nature and also

judge what part of the business cycle the company is

going through and its impact on near term earnings

prospects.

• How do you combine macro research and industry

screening?

We use a mix of top down and bottom up approach to

investments. Inputs from macro research such as

liquidity and interest rates, trends in fiscal policy and

nature of government spending, etc are important

factors in portfolio construction. So we take the views

of experts, both internal and external on these

matters. However, the key learning over the years has

been that bottom up research and valuations are an

equally if not more important driver of equity returns.

The extent to which macro factors are reflected in the

valuations needs to be examined carefully.

• How do you weigh various ratios & valuation

measures?

We evaluate a stock based on five key parameters:

efficiency of capital utilisation as indicated by return

on equity and return on capital employed, quality of

management, earnings growth prospects, valuations,

and liquidity. As stated earlier, we consider capital

efficiency to be a key parameter. We use return on

invested capital as the key measure of capital

efficiency. We also try to judge if the incremental

capital can be employed at similar rates of return or

not. Otherwise historical ratios can be misleading. The

relative valuation parameters such as P/E, P/B, EV/

EBITDA multiples provide a quick and useful guide.

However, one needs to see the relative valuations with

reference to other stocks in the same sector and that

stocks own historical valuation trends.

• Give us your views about markets? Which sectors

are you most bullish on?

We remain very positive on the markets from a

medium term point of view, despite the strong run it

has had in the last six months or so. We feel India is

coming out of its macro problems and is focusing on

improving its growth through improvement in

productivity. The business and earning up cycle has

just started. It is true that market valuations at about

17x FY15 and 15x FY16 are not cheap but they are not

expensive either.

We feel the large valuation differentials that

existed between cyclicals and secular growth

stocks have corrected to a large extent. The next

upmove in markets will be led by improvements in

earnings that comes with improvement in

economic growth. We are quite bullish on sectors

such as cement, auto and auto ancillaries,

discretionary consumption, select capital goods.

We remain positive on IT and select pharma

stocks.