Insights

FundsIndia Strategies: Should You Go for Infrastructure Funds?

April 15, 2014 . Vidya Bala

For those of you used to seeing your infrastructure funds languish in the last 5 years, the sudden uptick in the last 6 months may have come as a surprise. Infrastructure and capital goods-oriented theme funds delivered an average absolute return of 24% in the last 6 months alone. That’s higher than the 10.2% return of the Sensex, 14% return of a broader index such as the CNX 500, and in fact higher than even the 21% return of the CNX Midcap index.

So is this a signal for those of you stuck with this category of funds to exit? Or should you be entering now? And why the rally? Let us try and seek answers to these questions, taking the last one first.

Why the rally?

It’s easy to say that in a rally that takes place in anticipation of post-election growth reforms, infrastructure and allied sectors, which are the most hurt now, are more likely to benefit from such reforms; and hence the rally in this segment. But then, that is partly true.

With beaten down valuations and less signs of further deterioration, the market has seen selective opportunity in the sector when compared with more expensive sectors such as IT, pharma or FMCG. But then there were other factors at play over the last six months that provided some boost to select sectors.

We have stated them in our earlier equity strategy call and we reiterate them here:

  • In the power space, there has been a gradual hike in tariffs to reduce the losses of State Electricity Boards and aid their restructuring. Fuel supply uncertainty for power plants reduced after Coal India signed supply agreements.
  • In the oil and gas space, rationalization of subsidy is underway, what with gradual increase in diesel prices over several months now, leading to the diesel price being just a whisker away from its market price.
  • Export duty on iron ore and iron ore pellets has ensured better availability locally, keeping prices at bay for consuming industries.
  • In telecom, spectrum auction and spectrum trading, irrespective of election outcome, specific stocks may become major beneficiaries.
  • At a more macro level, the number of coal mining projects given clearance has shot up post November 2013, after change in the Ministry’s head. Besides, a number of stuck infrastructure projects such as the power project of NTPC have been cleared by the Cabinet Committee on Investments

More importantly, postponement of Base III norm adoption by a year has eased off the pressure of immediate capital raising requirement by banks, especially public sector ones, thus leading to a rally in the stocks. Note that banking stocks account for a good chunk of the portfolio of infrastructure funds as it is a theme directly related to infrastructure/economic growth.

It is for this reason that the BSE Capital Goods index rose a whopping 44% in the last 6 months, the CNX PSU Bank by 27% and the CNX Infrastructure by 18.5%.

But do the above positives mean that all is well with the infrastructure/engineering space?

Should you enter now?

This question is best answered if one is able to see clear prospects of growth in companies in this space.

table_15Apr

You need to keep in mind that many of them are not out of the woods yet.

For one, a good number of companies have not shown improvement in their earnings. Two, a number of the companies in the engineering/infrastructure space carry high debt in their books and with interest rates remaining high, their woes remain. Three, even assuming the markets are conducive for these companies to raise capital either for repaying debt or for fresh projects, this could result in earnings dilution, and may not really boost growth in the short to medium term.

That said, many companies, especially in the engineering space, that act as proxy plays to infrastructure, telecom or even automobile spaces, are ready with capacities and have otherwise sound fundamentals and balance sheets are waiting for the uptick. This could be companies that would benefit from the operating leverage.

Given the limited basket of quality companies to choose from today, we are of the opinion that one can play the theme without having to take exposure to infrastructure funds. Playing it safer with funds that have a wider theme like Franklin Build India, or better still, with diversified equity funds that have adequate exposure to this space, may be one way of avoiding the kind of risk that one took 5-6 years ago in this segment.

Our earlier call had 3 funds: HDFC Top 200, Franklin India Prima and ICICI Pru Discovery to play these themes with reduced risks. However, for those wanting to take the bull by its horns, PineBridge Infrastructure and Economic Reform Fund and HDFC Infrastructure may be worth a watch. While we are neutral on these 2 funds, we may review them at an appropriate time.

For those of you who hold infrastructure funds, this may be a good time to book profits or exit them if they account for over 10% of your portfolio, or your risk appetite or time frame does not permit holding high-risk funds. Of course, it is quite possible that you will miss a rally. Hence ensure you take exposure to the alternatives we suggest.

Disclaimer: Past returns are not indicative of future performance.

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