17th October 2011

WF : Its now almost a year since you launched the Principal Smart Equity Fund, as a solution that dynamically adjusts allocation into equities based on prevailing PEs in the market. How has the first year been in terms of performance?

Rajan : Following the crisis of 2008, we at the Principal wanted to deliver clearer alignment of interest with our investors by making possible a better upside participation while limiting downside risks. There was a definite need for simple to understand products which help retail investors minimise their mistakes and make the right asset allocation decisions.

This Fund has survived a turbulent equities environment in India when equity portfolio valuations have eroded significantly. The Nifty has lost 16.90%. Even the benchmark Crisil Balanced Fund Index lost 9.54%.

The Principal Smart Equity Fund lost a mere 5.6% since its inception on 16th Dec 2010 to 30th September 2011 and has proved to be a safe haven for equity investments.

WF : Heightened market volatility seems to underline the need for a disciplined mandate like what you have in the Principal Smart Equity Fund. Would you say that this mandate is more apt for volatile times or is it to be seen as an all-weather asset allocation product?

Rajan : It is true that the Principal Smart Equity Fund with its disciplined approach to investment based on its well-researched asset allocation strategy is possibly the best vehicle to deploy accumulations into equity for long term goals.

However, the real benefits of any such asset allocation strategy will only become evident when the investor stays invested in the longer term and across at least on market cycle and the associated volatility.

Remaining committed to such a product will ensure that, asset allocation is managed by informed professional in a disciplined manner. More importantly, wean away the retail saver from the two common pitfalls when it comes to equity investing; fear and greed.

WF : What is the present equity allocation in the fund and how has it moved over the last 6 months? At what PE level would you expect to be fully invested in equity markets and at current earnings levels, what Sensex level would that translate to?

Rajan : The equity allocation in the fund as at the end of September 2011 was about 64%. Based on the trailing PE bands; the allocation to equities has gradually increased over last six months from about 40-45% in Jan-Feb to present 64%. Especially, in the last two (Aug-Sept 2011) when markets witnessed a major correction and trailing PEs eased below the long term average.

In keeping with the Principal's stress on transparency, the PE bands have been explicitly spelt out in the Principal Smart Equity Fund's offer document. Under this mandate, the fund in normal market circumstances would be fully invested in equities when the trailing Nifty PE is 18 or lower. With markets having corrected sharply in October 2011, they are presently trading at trailing PE of about 17.6 (as at 7th Oct, Nifty 4888, Sensex 16232); the fund has the ability to invest fully in equity within the time period specified.

WF : Where is the debt / liquid portion of this fund allocated?

Rajan : As per its investment mandate, the Principal Smart Equity Fund can invest its non-equity component in debt including money market instruments. This will of course depend upon the prevailing interest regime e.g. given the upward pressure on interest rate regime and volatility; the non-equity component has been mainly deployed into near term money market instruments like CPs and CD upto one year duration. This is subject to continuing review of the interest rate environment.

WF : While the quantum of equity allocation is driven by the quantitative techniques, how are stocks within the equity component selected? Which of your equity funds does this equity component resemble most?

Rajan : The Principal Smart Equity Fund is managed on an independent strategy which allocates accumulations exclusively into large cap stocks.

The stocks in this category are selected through a bottom-up stock selection process which differentiates companies relative to their sector peers and is driven off our proprietary global research platform which works to achieve relative consistency in both rising and receding market conditions on an on-going basis.

Our process which aims to achieve superior stock selection is focused on early identification of changes in fundamentals and concentrates on companies with:

- Improving and sustaining business fundamentals

- Rising investor expectations

- Attractive relative valuations

WF : What is your outlook on equity markets over the next 12 months and what will be the key drivers?

Rajan : The uncertainty prevailing in the global markets due to the ups and downs in the US economy, the unrelenting debt crisis in Europe will keep equity markets volatile.

I do not see solutions in Europe emerge in a hurry and more likely to be incremental. The aftermath may keep European economy troubled for two to three years.

India cannot remain untouched either and one can expect the Rupee exchange rates, oil prices and exports to reflect the swings in the global economy.

On the other hand, the shortcomings in the Indian macroeconomic equation will come to bear heavily as well.

I however believe that, there is a high chance that, FII will continue to invest just because of the lack of alternative investment avenues bringing with them associated volatility and liquidity management pressures.

In the longer term keeping the long term India growth story in mind, markets will eventually payoff the patient and disciplined investor.

The Principal Smart Equity Fund which systematically accumulations into equity based on market valuations will ensure that, such investors benefit in the longer term by limiting downside risk.

I would confidently recommend this fund to personal investors who wish to allocate funds to the equity asset class as part of their retirement plan and wish to stay invested for the longer term.