WF: Three global factors seem to be worrying markets - Greece, China and Dubai. We have already seen close to US$ 3 Bn of FII sales in the last 20 days on the back of some of these concerns. Can you share your perspective on these concerns and what might be implications for our markets?

Jayesh Gandhi: On the issue of Greece, the concern is whether any potential defaults will have cascading effects on the banking sector in the developed world. Concerns on the financial sector have a magnified impact on markets as a whole. Our view - which comes from our large global strategy team - is that we are unlikely to see the issue develop into a major banking and sovereign crisis. We should also understand that Greece, Portugal, Spain all put together are relatively small part of EU. We believe that the EU will find a solution for Greece and other countries - as they are primarily facing a liquidity situation - in terms of meeting their debt obligations. We don't think this will have an impact on European banks - and therefore are not very concerned about this situation from an overall market perspective.

The second issue is the policy action in China. The fear is of the Chinese Government trying to slow down the economy - which is supposed to be the fastest growing economy in the world and the growth leader - will drag down global GDP growth. The Chinese Government is concerned about much larger or much faster increase in credit growth, etc, having a negative impact on inflation. But, it is unlikely that they will do anything to bring the growth rate down dramatically. Like the Indian Government, they are also trying to micro manage the economy into a moderate growth trajectory.

There are some areas where an impact will be felt - and others where it won't matter much. Say for example, commodity prices which were going up very fast, because of the growth in China, have corrected sharply. Copper and aluminum are now 20% to 30% below their recent tops - although they are still way above their early 2009 lows. The bubble like situation that had built up has got corrected.

What the Chinese authorities are doing, I believe, will enable a more balanced and sustainable growth - and is unlikely to derail the worldwide economic recovery process.

So, while these are concerns, they are unlikely to derail the global economic recovery story in 2010.

WF: From a domestic market perspective, there are concerns around the budget - the withdrawal of fiscal stimuli and rising inflation. How serious are these issues from a market perspective?

Jayesh Gandhi: Regarding the budget, the concern that people have is what kind of policy action will the Government take - especially withdrawal of stimulus in the form of roll back of the excise duty cuts. To my mind the budget will be reasonably okay, I think some of these concerns are also coming from the fact that last year after the budget, we had a pretty nasty correction in equity markets and so people are worried.

I think the Government has given a fair indication that it will now focus on controlling the fiscal deficit situation and that the stimulus is no longer required. Our view is that this will be very positive signal from an economic growth perspective. If the Government shows resolve in controlling its fiscal deficit, it will be a very important signal for equity markets, that the interest rate rise will be contained and not hinder economic growth.

The Government should also focus on channelizing domestic savings into productive investments. That would again be a very positive development from a long term perspective.

I think once the budget is tabled, the event risk will be behind us and markets will react favourably to this.

WF: How significant is the risk on inflation in your view?

Jayesh Gandhi: High inflation and hence higher interest rates appear to be pretty much factored into the prices today. We have already seen much larger increases in inflation, than what we had expected 3 months ago. For example we were thinking 8% range by the middle of this calendar year - it will probably be 1 - 2% higher than that. But, bulk of this is food inflation - not industrial products. Wages are also not abnormally high. Overall, while inflation is high, I believe by the middle of this year it will peak and then gradually taper off.

WF: What is your take on the recently concluded earnings season? Any sectors that have out or underperformed your expectations?

Jayesh Gandhi: It's been a mixed bag. For example, in sectors such as software services, private sector banks, pharmaceuticals companies, companies in the consumer products segment as well as autos, there have been positive surprises. The negative surprises have come in the expected areas such as PSU banks, oil & gas companies, particularly PSU oil marketing companies, telecom and select capital goods companies.

What we track more closely is the consensus one year forward estimates. Every quarter that companies declare results, it has an impact on analyst estimates for next one year. And we track that very closely. And the current earnings season has not caused any significant changes by analysts for their one year forward earnings projections. That is the key according to us. Analyst consensus remains for Sensex EPS growth of 20-25%.

WF: You have made a statement in your ACE Fund presentation that you see a repeat of the 2003-2007 period in terms of growth. Can you elaborate on this?

Jayesh Gandhi: We believe that this rebound in economic growth in India is sustainable over the next 3-4 years. We believe that GDP growth can accelerate to 7%-8% over the next 3 years. Assuming inflation at 5% - 7%, that gives a nominal GDP growth of around 14% - 15%. With that kind of GDP growth, earnings should grow by over 20% p.a. over the next 3-4 years.

Once this process begins, you will see markets reflecting and discounting a robust earnings growth story. That is exactly what happened in 2003-2006: we saw economic recovery and then growth and markets discounted this growth in a sizeable manner.

So if the economy and corporate earnings grow in the manner we are projecting, we are likely to see markets responding ahead of actual growth numbers - i.e. in the next two years.

WF: On the portfolio structure, you have talked about the Barbell strategy and how it has really helped you generate alpha in volatile markets. The question however is that if we believe in a secular bull market over the next couple of years, would a barbell strategy - with its defensive posture that acts as a counterweight to the growth oriented exposures - actually work against alpha generation? Would such a strategy come in the way of delivering outperformance?

Jayesh Gandhi: That is a very good question and valid one as well. Let me highlight couple of facts. We adopted this barbell strategy back in August - September 2009. Prior to that, when the market crashed in end 2008 - early 2009, we adopted an aggressive posture - we became fully invested in the first quarter of 2009- and participated in the rally that we anticipated would materialize after such a sharp fall. But, once the rally turned out to be stronger and swifter than most expected, we changed our strategy from pure growth to a barbell strategy. We expected a period of sharp volatility and positioned our portfolio according to that market view. The volatility took its time coming - it only materialized this year - but the barbell strategy has worked very well for us in limiting our downside during this correction.

WF: So, if I understand you right, you are saying that if indeed we see some more correction in the market, you won't hesitate to discard the Barbell and go for growth.

Jayesh Gandhi: Yes exactly. That is essentially the logic. I believe that probably in the next few months, we may see an opportunity to change course again, move away from the barbell strategy and go for growth.

WF: Finally, what can go wrong in whole India growth story? Since everybody seems to be gung-ho about it, I guess its useful to get a perspective from experts like you what are the precautionary notes we must keep in mind.

Jayesh Gandhi: I think the risks are two fold - one global and one local.

From a global perspective, India does not necessarily need a sharp global economic recovery to sustain its own GDP growth story. But what we need is for the global financial sector and banking sector to remain healthy and function well. India needs foreign capital to fund its growth plans. We get US$ 15-20 Bn a year in FDI flows and a similar amount in FII flows every year. That investment is critical to fund our economic growth plans - and for that, the global financial system needs to be robust. We saw in 2008, when the global financial markets were hit, there was a world wide credit and investment squeeze - which also impacted us. So, we need global credit supply to remain robust - else, there will be an impact on our own growth. Though we have a large pool of domestic savings, a significant part of our capital requirement comes from overseas.

The domestic risk factor we must watch is that the Government has a very strong opportunity to reform the Indian fiscal situation - and put the country on a higher growth trajectory. The flip side of this coin is that failure to address the fiscal deficit situation can derail the long term growth prospects of the economy. That could have negative repercussions on the equity market. One can argue that reforms happen slowly - but there must be a roadmap by the government which suggests that it will happen.

While short-term volatility continues, from a medium to long-term perspective the story for Indian equities is getting better and better.

The information being shared is for general information purposes only and is not intended as, nor capable of being, considered as financial advice or recommendation to deal in any security of any sector. Any views or opinions presented in this article are solely those of the Portfolio Manager and do not necessarily represent those of the Morgan Stanley as a Firm. Please note that stated points/beliefs about future events, such as market and economic conditions, or other projections are subject to market uncertainties. General business, market, economic and political conditions are dynamic in nature and could cause actual results to differ materially from what we presently anticipate or project herein.