BackWhere do ‘infrastructure’ funds invest?
It may be difficult to explain precisely. But thematic funds should stay true to their mandate
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As retail investors renew their interest in equity mutual funds (MFs), infrastructure funds are getting a lot of attention. These funds’ relative performance languished for quite a while, but the past few months have been rewarding—1-year average return for the category is 54% versus 5-year average compounded annual growth rate (CAGR) of 7.65%.
Before you get too enthused by the returns and invest in an infrastructure fund, spend some time to understand what constitutes “infrastructure".
The term itself encompasses various kinds of companies and even industries. For funds in this space, the lines are blurred around sectors to invest in. For example, while some invest in metals and oil and gas as part of infrastructure, others don’t.
Defining infrastructure
A document on the Planning Commission’s website lists out sectors that eight committees and agencies consider to be part of infrastructure. They are in agreement over at least 10-12 sectors being part of infrastructure, but some sectors, such as urban services, oil and gas, are ambiguous. Moreover, the note says, “While infrastructure is recognized as a crucial input for economic development, there is no clear definition of infrastructure according to the current usage of the term in India."
Fund managers, too, define infrastructure in different ways. While some stick to core infrastructure companies others also consider ancillary companies.
“We respect the investor’s choice and, therefore, it is a sine qua non to follow the mandate of the fund. We use the definition of infrastructure given by the Planning Commission of India as a guide to decide if a particular stock is related to the sector. The infrastructure sector has some unique characteristics such as natural monopoly, high sunk costs, non-tradability of output and so on." said Huzaifa Husain, head-equities, PineBridge Investments India.
But not every fund’s mandate is precise. Rupesh Patel, fund manager, Tata Asset Management Ltd, who also manages the infrastructure fund (one of the oldest in the industry), said, “The scheme information document clearly defines the sectors we can invest in. Essentially, any company that is directly or indirectly linked to creation of infrastructure and benefits in its growth finds its way into this theme."
Mahesh Patil, co-chief investment officer, Birla Sun Life Asset Management Co. Ltd, said, “There are two things to consider: companies that are directly in the business, such as construction and capital goods; and others that indirectly benefit from infrastructure growth. We consider both the aspects and then drill down to the investment opportunity in individual firms."
As a result of ancillary companies being included, infrastructure as a theme gets expanded to include sectors such as banking and metals. Thankfully, some sectors are clearly not infrastructure—information technology, healthcare and fast-moving consumer goods being a few.
“In our scheme information document, financials are included because any large public or private sector bank has sizeable exposure to infrastructure projects. With the new government, cash flows for some of these projects could get readjusted and that will impact a bank’s asset quality," said Patil
But only 20-25% of a bank’s loans are linked to infrastructure. Moreover, a bulk of banks’ non-performing assets come from segments such as small enterprises, agriculture and retail lending, which have little to do with creation of infrastructure.
There may be a link but in most cases it is not strong enough to determine that a bank or a financial company is part of the infrastructure sector. Companies such as IDFC Ltd and Power Finance Corp. Ltd lend solely to infrastructure-linked projects; their inclusion in the sector can be justified.
At present, of around 19 existing infrastructure funds, at least nine invest between 15% and 25% in banking stocks.
Another grey area is the oil and gas sector, and within that production, pipeline and distribution segments. Husain said, “While a hydrocarbon pipeline business belongs to the infrastructure sector, oil production does not. Imagine a scenario whereby, in the next decade, infrastructure in India improves but oil prices drop globally. Which factor will affect the oil producer the most?"
Soumendra Nath Lahiri, head-equities, L&T Investment Management Ltd, said, “Oil production and exploration (firms) are more users of infrastructure than contributors."
Not all agree. “Oil production requires investment in complicated, long-lasting infrastructure and does have a part in the segment," said Patel.
Eliminating companies and sectors from infrastructure is a complex task, said Lahiri. “Anything can be justified to be a part of infrastructure; the sector is broad and many industries benefit from it and also support it."
With metals, those who include it in infrastructure say metals form the building blocks of infrastructure. But the counter argument is that the final output is easily tradable globally and so the prices are affected by factors outside of the domestic economy, which disqualifies steel from being a part of infrastructure.
Mint Money take
The need to define infrastructure and its constituents arises because thematic funds in this space have very varied portfolios. Funds in other themes such as banking or information technology have precise definitions, which are difficult to breach.
Many thematic infrastructure funds have portfolios that look more like diversified equity funds. To be fair, standard scheme information documents only require 65% of the fund’s assets to be invested in that particular theme, and the fund manager has the leeway to invest the rest 35% elsewhere.
Mint Money believes that thematic funds should by and large be true to their mandate. The leeway to invest elsewhere should be used only if theme specific companies have been exhausted. So, a banking fund should be 90-100% invested in banks, and similarly an infrastructure fund should be mostly invested in the relevant core infrastructure companies. This way you can link your return expectation from a thematic fund to how the sector itself fares. If infrastructure companies and sectors are flourishing, then your fund has a high probability of delivering high returns; if not, then returns suffer. The danger of over-diversification in a thematic fund is that you may find it difficult to pin point whether the returns are commensurate with the sector’s performance.
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