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Infrastructure Funds: Are they a damp squib? - Outside View by PersonalFN

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Infrastructure Funds: Are they a damp squib?
Oct 5, 2011

New wave of reforms started in India way back in 1991, when the Government in power then decided to open up the economy through various policy initiatives such as deregulation, privatisation and reforms in international trade policies (which were aimed to achieve sustainable and higher economic growth rate.

Through integrated efforts, for the first time post-independence, India achieved the growth rate of around 9%. However, it was clear that to sustain such higher economic growth, India needed an overhaul in its infrastructure. This was because despite a nip-tuck in economic growth rate, India's infrastructure remained one of the least developed among some major economies of the world.

Even after 14 years of reforms, in 2005, India not only lagged the developed nations but scored miserably even when compared to other developing economies such as Brazil and China on the infrastructure development and its usage, on some of the vital infra parameters.

Infrastructure development Indicators
Infrastructure USA UK France Germany China Brazil India
Electric Power consumption (kWh, per capita) 13,694 6,252 7,677 7,113 1,783 2,020 476
Air Transport (Registered Carrier departure)* 9,969,599 1,018,118 728,081 1,023,858 1,349,269 514,700 330,484
Container Port Traffic** 34,299,572 5,986,582 4,490,583 12,765,326 105,976,701 6,246,096 7,888,990
(* Both Domestic and international take-offs; **Port container traffic measures the flow of containers
from land to sea transport modes) (Data as onthe end of calendar year 2005)
(Source: World Bank)

Some of the key challenges faced on the infrastructure development were:
  • Lower budgetary allocation and expenditure toward the infra space
  • Constrains in procuring financing (for infrastructure development)
  • Impediments in obtaining approvals and delays in awarding contracts
  • Poor private participation
  • Lack of tax incentives
But later, in the Union Budget of 2005, the then Finance Minister (FM) acknowledged the problems of India's poor infrastructure development. It was well recognised that India needed significant improvements in infrastructure without which the growth rate of 8%+ would be unsustainable. In order to augment the infrastructure development; government proposed to enhance the budgetary support and stimulate private participation in Infrastructure financing.

Attempts were made to catalyse growth by strengthening regulatory framework and providing much needed support to some of key infrastructure sectors.

On the onset of the second round of reforms, some of Indian mutual funds sensed the investment opportunity in various sectors of infrastructure such as power, roads, ports, irrigation and infra financing and launched infrastructure thematic funds in 2005-2006.But if we assess their performance today, it has been a mixed bag and not very luring. While the Indian economy was on an exuberant bull run since August 2005, until the U.S. sub-prime mortgage crisis emerged in the U.S in January 2008, fund houses focused on garnering more Assets Under Management (AUM) vide infra funds, and the performance too was quite eye catching. But during the bear cycle steered by the U.S. sub-prime mortgage crisis and the Lehman Brother bankruptcy, these funds were hammered substantially, and even today while the Indian equity markets have displayed a smart economic recovery, these funds have faltered on the performance front as RBI adopted anti-inflationary monetary policy stance - which in turn affected the underlying stocks of respective funds as high interest cost pinched their over-leverage balanced sheets.

How CNX Infrastructure has fared against some major indices
(Source: BSE, NSE, PersonalFN Research)

The above graph reveals that if you were to invest a sum of Rs 100 in the CNX infrastructure index on August 01, 2005 your money would have appreciated to Rs 158 (CAGR Return of 7.8%) as on September 28, 2011, whereas a similar investment in BSE 200 index would have more than doubled - yielding you Rs 207 (CAGR Return of 12.4%) and in S&P CNX Nifty Rs 214 (CAGR Return of 13.1%). It is also clear from the graph above that the infrastructure sector was the major gainer in the exuberant bull run of the Indian equity markets from August 2005, until the U.S. sub-prime mortgage emerged in the U.S. in 2008. But when the U.S. sub-prime mortgage crisis emerged it lost its way during the market mayhem and failed to gain the highs of its glory days again.

Performance across market cycles
Scheme Name Bull Phase Bear Phase Bull Phase
01/Aug/05 To 09/Jan/08 To 09/Mar/09 To
09/Jan/08 09/Mar/09 29/Sep/11
BSE-200 51.6 -59.0 33.9
CNX Infrastructure 72.7 -60.9 9.1
S&P CNX Nifty 50.3 -53.5 29.1
(Source: ACE MF, PersonalFN Research)

Deteriorating fundamentals of many companies, changing macro-economic conditions have affected the investors' sentiment negatively. Moreover, companies in the infra space are reeling under pressures and are impacted by the following factors:
  • Rising interest rates
  • Highly leveraged balance sheets
  • Working capital management problems
  • Slower execution of projects
  • Delays in resource procurement
  • Intense competition
Hence, the study of performance across market cycles also exhibits a dismal performance (of 9.0%) of the CNX Infrastructure Index during the recovery phase (after the U.S. sub-prime mortgage crisis and Lehman Brother bankruptcy) as against the luring performance of the BSE 200 index and S&P CNX Nifty Index.

How have infra Funds fared?
Scheme Name Inception Date 6 Mth 1-Yr 3-Yr 5-Yr Since Inception Std. Dev. Sharpe Ratio
Canara Robeco Infrastructure(G) 07-Dec-05 -5.0 -14.6 14.0 11.4 13.6 9.54 0.09
HDFC Infrastructure(G) 19-Mar-08 -13.5 -26.6 8.8 - 0.0 10.00 0.06
Birla SL Infrastructure(G) 17-Mar-06 -11.0 -25.4 8.4 6.0 6.6 10.14 0.06
DSPBR India T.I.G.E.R-Reg(G) 14-Jun-04 -11.1 -25.7 6.8 7.1 20.7 8.91 0.03
ICICI Pru Infrastructure(G) 12-Sep-05 -13.2 -22.5 3.7 9.6 16.5 8.45 0.01
Tata Infrastructure(G) 20-Jan-05 -13.8 -28.0 2.6 6.1 16.3 9.52 0.00
UTI Infrastructure(D) 19-Apr-04 -15.0 -28.2 -0.4 2.8 15.7 8.37 -0.04
Reliance Infrastructure-Ret(G) 20-Jul-09 -19.5 -41.2 - - -13.7 6.21 -0.26
Category avg of infra funds - -12.8 -26.5 6.3 7.2 9.5 8.89 -0.01
Category avg of opportunities funds style diver eq. funds - -8.2 -17.2 11.3 8.2 13.4 8.12 0.16
CNX Infrastructure - -13.2 -30.2 -6.9 -0.1 - 10.15 -0.06
BSE-200 - -12.5 -20.0 8.5 6.5 - 9.68 0.06
S&P CNX Nifty - -13.0 -18.0 7.4 6.7 - 9.09 0.05
Note: Category average of infra funds is the simple average of the funds in the peer table above, while
that of opportunities funds is the simple average of all opportunities style diversified equity funds.
(NAV data as on September 28, 2011. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period. Risk-free rate is assumed to be at 6.37%)
(Source: ACE MF, PersonalFN Research)

Thus even as far as performance of infrastructure funds is concerned, they haven't delivered very appealing returns. In fact fund houses following strong investment processes and systems too have delivered lacklustre returns as their portfolios felt the turbulence of sub-prime mortgage crisis in the U.S., Lehman Brothers bankruptcy and anti-inflationary monetary policy stance adopted by RBI. However interestingly while all these events did occur in the last 3 years, opportunities style diversified equity funds managed to sail well across time frame as their fluid investment style permitted it to take opportunities across sectors and market capitalisation, which thus enabled them to deliver luring risk adjusted returns (as revealed by their Sharpe Ratio), as compared to infra funds which exposed their investors to average risk (as revealed by their Standard Deviation) but generated abysmal risk-adjusted returns.

It is noteworthy that growing emphasis on the infrastructure development and the euphoria generated during the exuberant bull phase - prior to sub-prime mortgage crisis and Lehman Brothers bankruptcy made infrastructure a favourite theme in the year 2005. Many key sectors in infra such as construction and power, witnessed tremendous upsurge in activity as companies chalked out aggressive expansion plans, and investors too gave an overwhelming response to the capital raising plans of these companies. Holding some of these sectors and stocks therein Infrastructure funds certainly generated ecstatic returns during 2006 and early 2008, but later these same stocks were hammered during the downside of the Indian equity markets (from January 9, 2008 until March 9, 2009)

Some popular stocks held by infra funds in August 2005
Company Birla SL Infrastructure ICICI Pru Infrastructure Tata Infrastructure UTI Infrastructure Canara Robeco Infrastructure
Bharat Heavy Electricals Ltd. 4.1 - 5.3 6.3 4.3
Siemens Ltd. 4.8 1.9 5.3 - 3.9
Grasim Industries Ltd. 3.1 4.6 4.0 3.9 5.9
NTPC Ltd. 0.7 0.9 2.8 2.7 1.3
Crompton Greaves Ltd. 4.7 2.3 2.7 3.9 2.0
Gammon India Ltd. 0.5 - 1.6 2.8 1.6
Jaiprakash Associates Ltd. 1.0 3.2 1.4 - 2.7
BEML Ltd. 1.2 2.0 1.3 - 2.0
Portfolio as on August 31, 2011 Source ACE MF:PersonalFN Research)

(Source: BSE, NSE, PersonalFN Research)

For instance, stocks such as Bharat Earth Movers Limited (BEML)-one of the major players in manufacturing of mining and construction equipment and which supplies to nearly half the total market in India; was spotted in the portfolio of most infra funds experienced a humongous rally prior to the crisis, but now seems to faltering to generate wealth for investors.

(Source: BSE, NSE, PersonalFN Research)

The story of Gammon India Limited - one of the largest civil engineering construction companies in India, was no different. Despite having to its credit some the key projects such as India's first cable stayed bridge built in Sikkim, Asia's longest railway tunnel in Maharashtra; the stock has performed awfully.

The Road ahead & verdict

We recognise the fact that infrastructure need in India is clearly outpacing the supply. Infrastructure deficit has been glaring and impeding India's growth story. And to sustain the high growth rate (of above 8%), India has to show remarkable improvements in the quality of infrastructure. According to World Economic Forum, "India requires infrastructure investment of $1 trillion over five years starting in April 2012 as it aims to boost economic growth to 10%". This in our opinion will certainly provide an impetus to the infra theme (which at present reeling under pressures of high interest cost due their over leveraged balance sheets).

But we believe in order to take opportunities emerging in the infra theme, diversified equity funds following opportunities style of investing would enable to even out sector or theme specific risk well due to their fluid investment style and their trait of investing across market capitalisations and sectors. Moreover, you would also get the opportunity to be a part of other promising themes such as consumption and banking, which a sole infra fund may preclude you from.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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3 Responses to "Infrastructure Funds: Are they a damp squib?"

debu

Oct 8, 2011

Dr. Kapur is right. But what about respected Anna Hazare saheb and his team ? Union govt. is for the corrupt, by the corrupt and of the corrupt. If Mr. Hazare stands as an obstacle, no order will be passed. What will be fate of the Corporates who are accustomed to funding politicians and babus. The net results will be zero. Then what for Infrastructure funds ? It is only MNC and FMCG company like Dabur, Nestle, Colgate and drugs company which can confirm assured income.

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Sundar

Oct 6, 2011

Thank god. Luckily, knowingly or unknowingly we have not created physical assets as in the case of many countries. Every infrastructure has to be paid back in real sense. This is the fundamental issue in Western countries. I was driving in Athens in a 6 lane road and there is no car infront / back of me for 500 meters. How this asset can be paid off if this is the ussage. Classic case is Airlines. It is easy to buy planes. But, where are the customers at price which airlines want. We will sink, if we also mindlessly create infrastructure.

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Dr Rajeev Kapur

Oct 5, 2011

Nice analysis of infrastructure funds. Do u think corruption is an important factor in the poor performance? A union minister is said to take 10 to 20% for award of contract, the secy takes his 5% cut, the chief engineer takes 5% cut and down the line every stage 2% cut is added. You add income tax, local police, local civic bodies taking their share and you are left with little to finance the project. Loans from PSU Banks are obtained after bribing the bank managers and directors.H Such a project can take off but is never completed on time or is of poor quality. How Can an investor hope to get any return by investing in infrastructure funds in India?

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