WF: We have seen a fairly significant run up in markets over the last 9 months. Now, there are some rumblings from Dubai, Greece etc. Do you see risk aversion coming back due to these events and what may be implications on our markets as a consequence?

Srinivas Rao: I think the way we look at market is, if you are having a medium term perspective which is two to three years, we are fairly positive on market outlook. Over a shorter term, I would say we are cautiously optimistic. There are two factors that drive markets : number one - you have fundamentals - how Indian corporate sector performs for the coming quarter or two and and number two is : who are the buyers and sellers in the market. I think we are fairly comfortable about Indian corporate performance though the second quarter numbers if you see there was not much on top line growth but they have done very well in terms of efficiencies and cost cutting which gave good profit growth and all the indicators suggest that the economy is on a revival path.

But in the short term, we all know what happened last year and if you see what is happening now is FII's have come back with a vengeance into markets. While emerging markets have recovered substantially and developed markets indicators also seem to be turning better, I don't think the worst is over in terms of the developed world and that all the issues of 2008 have been fully addressed. I don't think for example that the excesses over 15 years in the US can be corrected in just 1 year.

Lets take Dubai. Many people knew for a year now that there have been excesses and these excesses will lead to problems ahead - and look at where we are today. I think there are such risks in the global market - which can in turn lead to rapid movement of flows.

This, coupled with the fact that in the Indian market, we are right now we are at 20 times FY10 earnings and some 17 times FY11 earnings - means that valuations are not cheap any longer. So it can lead to market correcting 10 - 15 % in no time. So that is why we are cautiously optimistic.

Having said that, when when we are constructing a portfolio, it is predominantly a bottom up approach, so we spend more time trying to understand companies and seeing how are they doing, sustainability of earnings and return ratios.

WF: When you talked about the last quarter results, you made an observation that the bulk of the profit growth has happened out of the cost cutting, we are yet to see a robust top line growth. Do you see anything in the horizon that will lead you to believe that the top line growth will now resume or will that be a matter of concern for the next 2 quarters?

Srinivasa Rao: In the last 12 months, consumption was led primarily by rural demand. The urban consumer is now coming back - which should help business volumes pick up further and result in some top line growth. Investment spending was muted in the last 12 months - we can now see clear signs of acceleration here. However, we must understand that when large projects get underway, the revenues don't accrue overnight - there is a lag of at least 6 months before you start seeing revenues from large projects.We are seeing a pick up in road contracts getting awarded, in power projects moving ahead - so there is a clear sign that both consumption and investments will help build good topline and bottomline growth in the year ahead.

WF: In terms of specific sectors that you are more optimistic about, from your November portfolio it appears that Banks and Pharmaceuticals and Oil & Gas are the three of the largest exposure that you have. Now within banks, there are some market players who worry that a rising interest rate scenario can dent treasury profits and therefore impact near term results of banks. How do you view this?

Srinivasa Rao: We believe that financials are the best play on the growth story, whether it is on the investments side or the on the retail side. So there is a huge opportunity for the financial services sector. People keep talking about the mortgage loans, penetration, whether it is credit card loans, whether it is home loans etc - these point out to vast demand for consumer finance. As mentioned, we will see a surge in investment projects - and again, all these projects will have a debt-equity ratio of 3:1 or 4:1 Every one rupee equity will need 3 to 4 rupees of debt funding - so banks would benefit from both these opportunities. Valuations are also attractive.

WF: So is it your view that the share prices of banks today discount a rising interest rate market, and therefore one should not worry too much about slightly weak FY 10 numbers, if treasury profits dip?

Srinivasa Rao: I think so, you have to understand when the interest rates are rising, that rise will happen only when there is a reasonable pickup in the economic activitiy. So interest rates may go up, but you will see that they have much more opportunities to lend.

WF: Coming to pharma, is your exposure more led by a defensive posture or do you see some fairly exciting growth prospects for the companies you own?

Srinivasa Rao: It is more of a bottom up and the growth that we see in the stock. I think in the pharma sector, for the last 10 years or so, they have gone through a tremendous learning curve, and they have become stronger, they have developed reasonable IP, skill sets - all that is coming into play now.

WF: Is it the generic export story that excites you?

Srinivasa Rao: It is both, I think the companies have got into combination of both, I think all the companies that you see in the portfolio have mix of both - you have generic exports as well as research plays.

WF: Which are the sectors that you are little cautious on? Which are the sectors you think have run ahead of their fundamentals?

Srinivasa Rao: We are underweight on power utilities, real estate, commodities like steel and cement.

WF: Why are you underweight commodities?

Srinivasa Rao: Commodities like steel is a global commodity and as I have mentioned in my initial observations, I am not very sure that the global recovery is fully underway and that everything is back to normal. There could be uncertainties on the demand-supply numbers. In cement, we can clearly see that there is a significant supply build up in the system in the coming months which will lead to over supply.

WF: Within entertainment your largest position is ZEE : what is the underlying investment theme that interests you here?

Srinivasa Rao: Instead of getting into stock specifics what we like is here are two things : (a) the consumption play - people will spend more on entertainment and (b) an improving revenue mix. If you see the revenue mix, they are getting higher share from subscription revenues. This was missing for the sector because of the unorganized sector. Growing subscription revenues are like annuity revenue streams.

The other factor is that in this sector, for some period you will be no.1 or no. 2, and then you will go down to no 4 - and again you come back to a leadership position. It's a cycle - I think everybody will have their share. If you time your entry correctly, you will see both ad-revenue and content-revenue going up.

WF: In fact on the subject of valuations, since you also co-manage the infrastructure fund, while a lot of people are obviously very optimistic about the long term growth prospects, there is a little bit of concern about valuations in the infrastructure plays being perhaps a little too rich. Do you share some of these concerns?

Srinivasa Rao: I definitely share those concerns, I think in the name of infrastructure some people are giving all kinds of companies a high valuation - I don't think that is going to work and we will have the situation wherein their will be big disappointments.

Infrastructure is a very broad term and wide term - it covers almost everything. So I think, that is where one has to go for bottom up approach. In infra, you have roads, you have power, you have ports, you have real estate, you have oil & gas. I think one has to get into details as to what the company is into and what are their plans and evaluate them carefully rather than buy just because they bag few projects. In infra, you have broadly two categories,

1. the company which actually executes contracts like engineering companies

2. there are companies which own the assets.

So one has to make the distinction between these two and value them appropriately.

WF: Some people also worry about the execution risk : many infra companies are planning to execute projects far in excess of what they have done in the past.

Srinivasa Rao: I think it is very much a real risk. If a company has been executing say 10 kms of road construction per day and are now saying they will do 100, you know that can't happen. Maybe 10 can g to 20 or 30 - beyond that, its very difficult to scale up so quickly. That's where you have to do your homework and assess what they company has done to enhance their capabilities to achieve a higher scale. There will be disappointments in execution

WF: What's your view on the IT Sector?

Srinivasa Rao: IT we are marginally underweight. Its more to do with the rupee, I think business front things are improving, I think if India does very well, the rupee will get stronger. They will face some marginal pressure then.