HDFC Prudence recently completed 20 years of astounding wealth creation : 35 X appreciation in 20 years in a balanced fund (CAGR of 19%) is quite honestly, nothing short of astounding. Prashant Jain, widely regarded as one of India's ace wealth creators, has been steering this success story through these tumultuous 20 years, and has witnessed many highs and lows in this eventful journey. Prashant shares 4 key lessons that he has learnt in this 20 year journey - which we would all do well to reflect on, imbibe and pass on to our investors. Read on as Prashant also discusses his outlook on debt and equity markets and analyses the reasons for the dip in 2013 performance and the subsequent bounce back.

WF : Congratulations on HDFC Prudence completing 20 very distinguished years of wealth creation. What have been your key learnings from the remarkable journey of this iconic fund?

Prashant : My sincere thanks for the kind words. Whatever I have learned, I owe it in substantial part to this Fund. Some key learning's:

1. A 19% CAGR over 20 years makes Rs 10 to Rs 352* (Adjusted NAV of HDFC Prudence Fund as on 31st March, 2014). I had only read Einstein on compounding, but this was a first hand experience.

2. Patience is a virtue in investing, but in short supply with most. This 20 year journey has seen many ups and downs for India, for stock markets, for NAV, but over time like the Indian economy that keeps on growing, the NAV has also grown. Unfortunately very few have benefited from this to the full extent as only ~23% of investors have a holding period of more than 5 years in the Fund. There are ~2,500 exceptions though. These investors have stayed with HDFC Prudence Fund for these 20 years and have benefited from the Fund.

3. Good and bad times do not last - I have experienced this on several occasions. There have been times notably 1995, 2008, 2013 etc that have not been good for the Fund's performance. This led to a lot of introspection, some valuable insights, corrective action and improved performance subsequently.

4. In this journey of 20 years, I have seen FII ownership of Indian stock markets go up from nil to ~23%, i.e., roughly 1% a year. This implies that Indians themselves have reduced ownership to this extent and have not benefited from this growth economy. This is unfortunate. I would simply urge Indians to take advantage of the good growth prospects of Indian economy and the compounding prospects of stock markets. Returns of funds such as HDFC Prudence Fund demonstrate the benefits of long term investing and there is a strong case for Indians to allocate more to equities.

WF : What are some of the key lessons that investors and distributors must imbibe from the fund's 20 year journey? How many investors do you have who have remained invested in the fund since inception?

Prashant : Investors and distributors - not all, but many give a lot of attention to timing the stock markets and to short term fund performance. In the journey of NAV from Rs 10 in February 1994 to Rs 352* on 31st March, 2014, there have been several ups and downs - both in markets and in performance. Today, these appear to be insignificant- for example NAV fell from Rs 31.3 in Jan 00 to Rs 21.9 in Apr 01 (S&P BSE SENSEX fell from 5336 to 3184), NAV fell from Rs 218 in Jan 08 to Rs.107 in Mar 09 (S&P BSE SENSEX fell from 20873 to 8160). Those who got distracted by timing the markets or the returns missed the big picture of compounding. Instead those, who focused on asset allocation and on long term and invested a meaningful part of savings in equities for long term have benefited. To take a crude example, a great timer who invests 1% of wealth in equities hardly benefits compared to someone who invests 20% of wealth in equities for the long term even if his timing or fund selection is not the best. The key thus is asset allocation, and unfortunately, most Indians would fail this test as equities have a minuscule place in our savings. As mentioned above, there are only 2500 investors who have been invested in this Fund since its inception.

WF : Prudence has become a dominant leader of the balanced funds category and has been an advisor favourite consistently over the years. What in your opinion helped create this leadership position in the balanced funds category for Prudence?

Prashant : The prefix "HDFC", the long term track record, the decent investment performance have all contributed to this position. Our disciplined and long term focused approach to investments has not only led to good performance in medium to long term but also led to good recovery in performance on occasions when performance suffered. This in my opinion has given confidence to investors and distributors to invest for the long term with us. Finally, the dividend track record of HDFC Prudence Fund has been consistent. HDFC Prudence Fund has given dividends in each of last 15 years.

WF : Many people in the industry believe that balanced funds as a category should have been much larger than what it currently is. What in your opinion has not been done well enough by the industry to make balanced funds more relevant to retail investors?

Prashant : I do not have clear views on this, however what is very clear is that equity ownership in India is very low and there is a strong case to increase it. Whether, this is done through Equity and Income Funds or Balanced Funds would depend on the individual choice.

What do percentiles and their colours signify?

Fund performance is typically measured against benchmark (alpha) and against competition. Performance versus competition is measured through percentile scores - ie, what percentage of funds in the same category did this fund beat in the particular period?

If a fund's rank in a year was 6/25 it means that it stood 6th among a total of 25 funds in that category, in that period. This means 5 funds did better than this fund. In percentile terms, it stood at the 80th percentile - which means 20% of funds did better than this fund, in that particular period. If, in the next year, its rank was 11/26, it means 10 other funds out of a universe of 26 did better than this fund - or 38% of funds did better than this one. Its percentile score is therefore 62% - which signifies it beat 62% of competition.

Most fund managers aim to be in the top quartile (75 percentile or higher) while second quartile is also an acceptable outcome (beating 50 to 75% of competition). What is generally not acceptable is to be in the 3rd or 4th quartiles (beating less than 50% of competition). Accordingly, we have given colour codes aligned with how fund houses see their own percentile scores. Green colour signifies top quartile (percentile score of 75 and above), yellow or amber signifies second quartile (percentile scores of 50 to 74) and red signifies 3rd and 4th quartile performance. A simple visual inspection of colour codes can thus give you an idea of how often this fund has been in the top half of the table and how often it slips to the bottom half. A great fund performance is one which has only greens and yellows and no reds - admittedly a tall ask!

WF : Analysis of recent performance of Prudence vs peers suggests that after 4 years of being in the top or 2nd quartile, the fund slipped vs peers in the first 3 quarters of 2013, before bouncing back in the last quarter of 2013 and the first quarter of 2014, back to a top quartile position. What were some of the factors that caused the dip in performance and what have you done to bring it back to a top quartile performance?

Prashant : It is true that the performance was not upto the mark in first half of 2013. It is also true that performance has improved meaningfully in recent quarters.

Equities are an asset class where in my opinion, the right time frame to measure performance is 3-5 years and longer. Too much focus on short term performance - both for investors and for fund managers can be counterproductive. Our both medium and long term performance is solid i.e., NAV in Jan 2008, when S&P BSE SENSEX was at 21000 was Rs.218*, today at the same S&P BSE SENSEX it is Rs.352*. What basically hurt the performance in 2013 was a more optimistic view of the economy; tapering concerns upset those expectations, but now things appear to be getting back to normalcy.

WF : What is your outlook on debt and equity markets for FY14-15 and what will be the key drivers for both markets?

Prashant : Economic outlook for India is improving. The problems of CAD, Fiscal deficit, stuck projects, INR volatility, high inflation, and high interest rates are slowly and steadily being resolved.

Fixed Income Outlook:

Key drivers to Interest rates are Inflation, Fiscal Deficit and stability of INR.

High food and vegetable inflation is behind us and core inflation has been moderating (see chart below). With slowing demand, stable commodity prices and INR, in my opinion, inflation in 2014 expected to be lower than in 2013

On Fiscal front, over the last few months, diesel price hikes have continued despite upcoming elections. Continued diesel price hikes will play an important role to reduce fiscal deficit in FY 15 and beyond.

CAD and BoP have also shown sharp improvements and would continue to do so in FY 15 based on faster export growth and slower import growth led by improving growth of software services and lower/stable oil prices. This should lead to a stable INR.

Thus, the key indicators point towards lower interest rates in FY14. I expect the interest rates to fall from current levels, however the exact timing and extent is uncertain.

Equity Outlook:

S&P BSE SENSEX currently trades at a PE of ~14.4x** one-year forward earnings. Earnings downgrade cycle is over and earnings estimates are witnessing upgrades. Thus, apart from growth in P/E multiples, even earnings may surprise on upside. The key to sound investing is to invest at low P/Es. Past data suggests that investments in equities made in low P/E markets (say a P/E below 15 - highlighted in Green) have done well over 3-5 years; on the other hand in high P/E markets (say a P/E of more than 20 - highlighted in Tan), investors should be cautious.

** (Source - CLSA Research, as on 24th March, 2014)

Price to earning ratio (P/E) is a measure of price paid for a share relative to the profit earned by that share;

N.A. = Not applicable, (Source: CLSA Research, Bloomberg)

Conclusion:

India is a secular growth economy and in our opinion, growth prospects remain good from a medium to long term prospective. The issues that hurt our economy over last few years are steadily getting resolved and outlook is improving. Interest rates are near peak and equity markets are trading at a PE of ~14.4x** one-year forward earnings which is below average. In view of above, in my opinion, outlook for economy, interest rates and equity markets is positive with a medium to long term view.

** (Source - CLSA Research, as on 31st March, 2014)

* NAV of HDFC Prudence Fund is adjusted for dividends declared prior to creation of Growth and Dividend Plans. For latest NAVs please refer to website of the Fund www.hdfcfund.com

Note-: Reference to S&P BSE SENSEX is only for easy understanding of market movement vis-Ã -vis the Scheme performance and not to be construed as measure of the Scheme performance. The Benchmark for the Scheme is CRISIL Balanced Fund Index.

DISCLAIMER: The views expressed by Mr. Prashant Jain, Executive Director & Chief Investment Officer of HDFC Asset Management Company Limited, constitute his views as of Mar 31, 2014. The views are based on internal data, publicly available information and other sources believed to be reliable. Any calculations made are approximations, meant as guidelines only, which you must confirm before relying on them. The information contained in this document is for general purposes only. The document is given in summary form and does not purport to be complete. The document does not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. The information/ data herein alone are not sufficient and should not be used for the development or implementation of an investment strategy. The statements contained herein are based on our current views and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Past performance may or may not be sustained in future. Neither HDFC AMC and HDFC Mutual Fund (the Fund) nor any person connected with them, accepts any liability arising from the use of this document. The recipient(s) before acting on any information herein should make his/her/their own investigation and seek appropriate professional advice and shall alone be fully responsible / liable for any decision taken on the basis of information contained herein.

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