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Dear Policyholder,

Let me begin with a quote from Warren Buffet – "I will tell you how to become rich. Close the door. Be fearful when others are greedy. Be greedy when others are fearful." Most asset managers are at a stage where fear has triumphed over greed. Markets have become very pessimistic. To quote Bill Gross of Pimco – "the new normal of slow growth has given way to the paranormal, an environment characterized by credit risk and zero base rates." Another market guru says – "predictions for the equity markets have never been more difficult - there are too many variables which are beyond comprehension."

I have always believed that crystal ball gazing is a futile exercise. More often than not, most of what we predict at the beginning of the year turns out to be wrong by the end of the year. But it is also true that the best time to profit from asset markets is when there is blood on the street. 2012 will be a year of great opportunities for long term investors though it will also be a year of tough choices but investors will need to find the right answers to make robust investment choices.

Rising inflation was a big concern in 2011 but hopefully 2012 will be different. Food inflation will turn negative and core inflation will moderate downwards. This, coupled with the base effect, will ensure that inflation softens to below 7%. Oil prices are unlikely to remain outrageously high in 2012. This may allow the government to push through a moderate diesel price hike, helping improve the fiscal deficit situation. With inflation easing and growth slowing down, RBI is expected to bring down the repo rate by at least 150 basis points. This should cause interest rates to fall and the 10 year government bond yield could drop to below 8%.

Much of the growth in the last decade was driven by a strong investment cycle. This came to a halt as the government found itself in the midst of multiple crises in 2011. The reform process was stymied. While politics could still be a spoiler for reforms, there are signs that the government will seize the opportunity in 2012, its last chance before the 2014 elections, to push ahead with reforms. The policy paralysis was one of the reasons that slowed growth in 2011-12, which is expected to slow down to 7%. 2012-13 may not see a big recovery in GDP growth and the consensus estimate for GDP growth for 2013 is 6.8% to 7%. In spite of this slowdown, growth in India will be one of the highest in the world.

The long term BSE Sensex EPS CAGR has been around 15% and we expect this trend to continue. While there have been headwinds in terms of rising interests costs, higher commodity and input prices and a squeeze in margins, EPS growth will still be in its high teens which implies that the long term growth trend is intact. Indian equity markets are no longer expensive. The 12 month forward Sensex P/E at 12.6 times is lower than its 10 year average of around 14.6 times. Even the Sensex P/B at 2.2 times is lower than its 10 year average of 2.6 times. The market cap to GDP at 55% is almost half of its 2008 peak of 100%. Valuations for the Indian market have thus slipped to below historical averages and Indian equity is now looking attractive.

While 2012 will be a year of challenges, it will also be a year of opportunities. Debt investors will be able to see portfolio gains as interest rates will certainly fall. Equity market valuations are below their historic averages and earnings expectations are in line with the long term average. For equity investors, the last decade has given them a CAGR return of 17% and the next decade should also be able to deliver similar returns.

Wishing you all a great 2012.

Warm Regards, Sashi Krishnan