Want to ride the infrastructure theme?

Investing in thematic funds is not as easy as it sounds. And the time to enter is when it is at its lowest. Rohit Singhania, co-head, equities, DSP Mutual Fund, shares his insights.

You manage India T.I.G.E.R. which is an infrastructure-focused fund. Do you think prioritising government spending on the infrastructure and allied activities will help kick-start the economy?

The need for government spending on infrastructure was felt even before COVID when the country was facing a lower GDP growth for fiscal FY2019-20. The government reduced corporate tax rates in September 2019 to pass on the benefits of lower prices to consumers to boost consumption. While this was a very welcome step, this initiative didn’t help the infrastructure sector because it needs government capital. There are expectations of government coming out with a stimulus in terms of capital spending towards infrastructure development in order to have a multiplier effect on the economy.

Core infrastructure stocks such as in the roads, construction and Engineering, Procurement, Construction (EPC) space are still lagging other sectors during the recovery phase even though several sectors have recovered sharply.

Have you made any changes recently?

In our diversified schemes, in March 2020, we cut down our exposure to companies with high debt. However, in the roads, construction and EPC space, you will find that most companies have some amount of debt on their books, barring a few. The execution of order books has got further delayed due to a shortage of labour. Unlike FMCG and IT firms, infrastructure firms have limited ability to cut costs.

Besides order books, we look at the company’s cash flows. Business and balance sheet are the key drivers.

Some economists are predicting 7-8% of GDP de-growth this year. Government finances, in terms of tax collections are also expected to be lower. Thus, we are not seeing any euphoria in the infrastructure space.

There are various themes within infrastructure. Around ten years back, power generation companies were in vogue. Gradually, due to overcapacity and other issues, there was a feeling that these companies may not sustain the growth. Over the last four years, companies engaged in urban infrastructure, railways, roadways, etc. have caught investors’ fancy.

Currently, power generators which have the capacity and sell power to end consumers are in a sweet spot. Their capex is over, fixed costs are the same and thus the Return on Equity (ROE) should improve with rising utilization. Businesses in roads, urban infra, transmission, distribution are seeing some picking up. It is unlikely that someone will set up a new steel or power plant in the next year. Even for companies that were involved in setting up such factories in the previous peak cycle of 2000-03, the consensus has changed.

You manage DSP Natural Resources and New Energy Fund. What kind of opportunities can Indian investors expect?

As per its investment mandate, the fund can invest up to 35% of net assets in two of BlackRock’s funds – Sustainable Energy Fund and World Energy Fund. The balance in Indian equity in energy stocks, metals, commodities, mining stocks, etc.

We have recently taken fresh exposure to the World Energy Fund and increased exposure to the Sustainable Energy Fund. We believe international companies offer a pure-play investment opportunity on certain themes. Such opportunities are not available in India.

There has been a push towards clean energy worldwide. In India, there aren’t pure-play companies focused on generating sustainable energy in the listed space, except for gas companies.

When we look at the commodity prices, valuations of such stocks, the dollar index and inflation, history tells us that commodities tend to outperform in such situations.

So you feel the time is right to invest in this fund?

The metals sector is trading at a discount of 42% to the long term average. Similarly, oil and gas sector is trading at a discount of 30% to the long term average. So purely on the valuations front, we believe an investment case can be made. However, other things need to be considered as well.

When it comes to metals, investors need to keep in mind that these are global businesses and a lot of our companies have significant exposures to the European and U.S. markets. Such companies tend to have high financial leverage. In some cases, companies have high promoter level debt. So for this segment to do well, it is very important to gauge how the global economy shapes up post the COVID-19 pandemic.

On the energy side, we have seen huge capex curtailment by global giants sighting economic unviability. Looking at the marginal cost of production and budget deficits of oil-producing nations at current crude prices, gives us some hope of near-term price protection.

The companies the fund invests in tend to be very large and well-established businesses, with high entry barriers. The fund provides a good diversification option to an investor.  We would encourage only investors with a higher risk appetite and a good understanding of previous cycles to consider this fund at this juncture. Such funds are typically meant for investors who understand the risks.

Going by your last point, how should an investor approach a thematic fund?

Around 10-15% of one’s investable corpus can be invested in sector funds. It should be a tactical allocation. One needs to invest in these funds during uncertain times. For instance, the stock prices of infrastructure firms tend to react when they bag orders, irrespective of whether the actual execution happens on time or gets delayed. Additionally, infra firms tend to have debt on their books.

DSP Natural Resources & New Energy Fund is one notch higher in terms of risk in comparison to T.I.G.E.R. Fund. Investors need to understand the risks first and should consult their financial adviser before making any investment decision.

Source: Morningstar India Website