FUND FLAVOUR

October 2012

One-way ticket to glory?

In the heydays of the bull-run, investors considered sectoral funds as their one-way ticket to gains and glory. Things, however, changed when markets tumbled and sectoral funds started under performing broader markets much to the disappointment of investors in these funds. Sectoral funds - mainly investing in infrastructure, banking, IT, FMCG, and pharma stocks - had assets worth Rs 19,000 crore under management at the end of January 2012. Barring FMCG and pharma funds, no other category of sectoral funds has generated decent returns for investors in the past one year.

Infrastructure Funds

Light at the end of the tunnel…

Infrastructure funds have been the biggest casuality in the stock market downturn. A bleak sectoral outlook and underperformance of funds prompted investors to redeem about Rs 3,500 crore worth of investments from core sector funds last year. Policy inaction, higher interest rates, and slow infrastructure building activity are touted to be the major reasons for the underperformance of infrastructure stocks. Infrastructure funds have been the worst performers of the year with most funds logging negative returns in the range of 10 to 15%. The ET Construction Index, which includes most infrastructure stocks, has fallen over 17% over in the past one year. During the same period, CNX Infrastructure has outpaced BSE-200 only twice on monthly returns basis (i.e. in June 2011 and January 2012). Policy paralysis of Government, bottlenecks in funding, and high interest rate scenario have been delaying the revival of corporate capex cycle. But investors in infrastructure funds are expected to soon recoup most of the losses. The 12th Five-year Plan, which aims at 9.0%-9.5% growth, came into effect from April 1, 2012. To achieve this growth rate, heavy investment of around Rs 45,00,000 crore needs to be done in sectors such as electricity, roads and bridges, telecommunications, railways and irrigation to name a few. Infrastructure builders will also benefit from a probable decline in interest rates. The Finance Ministry has announced guidelines for establishing infrastructure debt funds. Recently, LIC, Bank of Baroda, ICICI Bank, and Citicorp Finance India have, in joint venture, set India's first Infrastructure debt fund with an initial capital of USD 2 billion. Unlike an IT sector fund, infrastructure funds are not focused on one area (or segment) of business. The sector covers infra builders, construction companies, engineering companies, and infrastructure financing companies, giving fund managers enough room to straddle between companies within the sector.

Banking Funds

Scope for improvement

Bank shares have under performed broader markets over the past year on concerns of higher interest rates, rising non-performing assets, and slow credit growth. The BSE Bankex Index has gained just about 0.5% over the past one year. However, the sentiment has turned slightly positive after the Reserve Bank of India announced rate cuts in January 2012. Banks are expected to perform well once rates start hitting the downward trail. Net interest margins are also likely to improve in the upcoming quarters. Funds with higher PSU banks in their portfolios are likely to generate better returns as PSU stocks have been oversold and under-owned in the market currently.

Technology Funds

Concentrated risk and volatility…

IT funds started performing towards the fag end of 2011 - mainly on the back of a depreciating rupee. IT shares have also appreciated on talks of stable growth in the US and continued order flows from American software giants. The general consensus among analysts is that IT companies will continue to log positive revenue growth in 2012. The weak rupee will also benefit IT companies significantly in 2012. Diversification is lowest in the IT sector. IT fund managers do not have the luxury to straddle between different businesses within the IT vertical. Investors, who do not have any binding reason or logic to invest in the sector, may exit at gains and redeploy the money in diversified fund portfolios.

Auto Funds

Auto Ancillaries to the rescue…

Domestic mutual fund managers have taken a fancy for the auto-ancillary industry as an alternative investment option in recent times as the auto sector has slowed down. The mutual fund industry has deployed 2.46% of its total equity investments in this sector in August 2012 alone against 1.99% at the beginning of 2012. This is the highest percentage investment made by the industry in this sector since January 2011. The past few years have seen a stupendous sales growth in the auto sector, which has created a healthy demand for replacement of auto parts today. Investment interest is especially high for companies catering to the replacement market like batteries and tyres. The auto-ancillary companies are holding firm in uncertain times and the industry has logged average sales growth of 30% in the past three quarters. Even though the demand from the original equipment manufacturers has dipped, the replacement market remains strong, which has helped these companies improve their operating margins to 20% from 15% over the past three quarters. Though sector performance is robust, high valuations may impact future investments. The 12-month trailing price-earnings multiple for the ET Auto Ancillary Index stands at 21.19, pretty close to its 2007 peak of 25.29, hinting that the future growth may have already been priced in. However, if industry experts are to be believed, these valuations may be re-rated if margin expansion story plays out as anticipated.

FMCG Funds

Kings of bad times…

Funds investing in FMCG companies have lived up to their reputation of being 'kings of bad times'. The BSE FMCG Index has significantly outperformed the Sensex during the last one year and this trend has been maintained in the last quarter on expectations of continuing momentum in growth that the sector has been witnessing. The sector is expected to report a double-digit revenue and profit growth in the next year driven by improving demand and pricing scenario and benefits from capacities set up in tax free zones. Raw material prices are slated to go down with prices of palm oil, milk, and soda ash declining. With continued rise in crude oil prices, the companies are expected to incur high packaging costs. Companies are expected to record margin expansion in the range of 20-520 bps.

Pharma Funds

A safe bet…

Pharma funds have managed to perform above average and have delivered CAGR of 28.8% (average of pharma funds) in the last three years and CAGR of 13.28% in five years. Meanwhile, the BSE Healthcare index rose 25.25% and 12.19% respectively for the same time frame. Volatile market conditions also prompted investors to flock to defensive sectors, helping the pharma category of funds to appear among the top gainers.

PSU Funds

Phoenix from the ashes?

Over the past 12 months, mutual funds have significantly pared their holdings in blue chip state-owned undertakings amid concerns that the Government is increasingly intervening in their business. Domestic mutual funds and UTI have reduced their holding in five out of the six PSUs that are part of the Sensex. While PSUs have gone out of favour, 14 of the remaining 24 companies on the Sensex have seen the stake of mutual funds in them rise. In nine others, mutual funds cut their share. The waning interest has not only eroded the valuation of PSUs, but also pulled down the broad market movement. In the 12 months ending March 31, 2012, the 30-share Sensex lost 10.5%. But the 60-stock PSU index fell much more — 18.4%. More significantly, the 60 PSUs lost more in market capitalisation in absolute terms than the Sensex itself. While the Sensex market cap dropped 9.1% or Rs 2.94 lakh crore to Rs 29.28 lakh crore during the last financial year, the market cap of the 60 PSUs plunged 18% or Rs 3.5 lakh crore to Rs 16.09 lakh crore.

After a sluggish performance in 2012 till the end of August 2012, PSU Banking Sector Funds have made a strong come back in September 2012. Kotak PSU Bank ETF appeared at the top in the list of banking sector funds with 18.42% returns and Goldman Sachs PSU Bank BEES followed it with 18.37% returns, as on September 26, 2012. The PSU banking space suffered after first quarter results were announced. Fall in margins due to slippages and high cost deposits along with declining CASA levels were the main culprits. Analyst community was wary of deteriorating asset quality of PSU banks. But as the Union Government opted for a slew of reform measures, the PSU banking space has seen renewed investor interest. The announcement on state electricity boards' loans restructuring has further pushed up PSU bank stocks. Market participants expect PSU Banks to benefit from lower interest rates and improvement in asset quality over the next one year.

 

Handle With Care!

Sectoral funds should be chosen as the investment instrument only if the funds  abide by the mandate of being a sector-oriented fund, has a good track record, and the investor is comfortable with the growth potential of a particular sector. If the sector tends to be cyclical in nature, investment can be made for a relatively shorter period of 3-5 years. Over a longer period of 10 years or so, returns from these funds even out and cannot match the performance of diversified equity funds. However, there are sectors such as pharma, FMCG, IT, which are not cyclical in nature and one does not need to book profit on a regular basis. Sectoral funds should not constitute more than 10% of the portfolio.