Are Infrastructure Funds a Worthwhile Investment after Modi’s Gati Shakti Plan?

October 19, 2021 Mutual Fund

The Indian equity markets are making fresh highs regularly, and the bulls seem to be in full charge. Many of you might be wondering, which is the best mutual fund scheme to buy at this juncture as the stock markets appear overvalued.

Of late, the infrastructure theme has been grabbing the spotlights–thanks to favourable valuations of the sector, the upswing in the business cycle, the announcement by the Mod-led-NDA government to develop India’s infrastructure, increasing investments, and the growth potential it offers.

Recognising that good infrastructure is an enabler for economic growth, the government seems focused on improving India’s infrastructure —be it the construction of roads, bridges, dams, railway lines, airports, renewal energy, telecommunication, housing projects, etc. This, in turn, is attracting several private investments and proving to be a potential boon for the Indian economy.

As per NITI Aayog, every Indian Rupee that the government spends on infrastructure development can add Rs 2.5 to Rs 3.5 to India’s GDP.

The National Infrastructure Pipeline (NIP) for FY 2019-25 is the first of its kind, whole-of-government exercise to provide world-class infrastructure to citizens and improve their quality of life. The total capital expenditure in infrastructure sectors in India during fiscals 2020-2025 is projected at ~Rs 111 trillion.

Graph 1: The sector-wise break-up of this capital expenditure of Rs 111 trillion under NIP

(Source: Report of Task Form for National Infrastructure Pipeline, Department of Economic Affairs, Ministry of Finance)  

To fund the enormous expenditure to improve India’s infrastructure, besides budgetary allocations and strategic sales, the government is working on an ambitious plan of asset monetization. The monetization plan worth Rs 6 trillion is likely to free up capital and would be channelized for infrastructure development.

Last week, Prime Minister Narendra Modi launched Gati Shakti, a Rs 100 trillion national master plan for multi-modal connectivity. This is a digital initiative that will get 16 ministries on one platform for coordinated planning, implementation, and monitoring of infrastructure projects. This would do away with the delays in getting project clearances, poor planning, cost overruns, cut logistics costs, provide more visibility and make available the information/data on a real-time basis, in addition to creating more employment opportunities. All of this together is expected to bode well for India’s overall economic growth. As per the government’s assessment, working in silos currently has hampered holistic infrastructure development and resulted in wastage of the budget.

Infrastructure companies celebrating on Dalal Street

Over the last 1 year, the Nifty 50 Total Return Index (TRI) has generated 57.8% absolute return whereas Nifty Infrastructure TRI has yielded 74% absolute return (as of October 14, 2021).

Graph 2: Nifty Infrastructure V/s Nifty 50

Data as of October 14, 2021
Note: The chart above denotes the performance of Rs 10,000 invested in Nifty Infrastructure TRI and Nifty 50 TRI
(Source: NSE, PersonalFN Research)  

If you recollect, in the earlier multi-year bull-run of 2003-08, the infrastructure theme did incredibly well. Many mutual fund houses launched dedicated infrastructure funds to capitalize on the market opportunities. Some of them did well in the initial phase when the market sentiment was bullish, but post the global financial crisis, the infrastructure sector funds didn’t generate returns as investors had expected, leaving them high and dry. Then over the last decade, the appeal of the infrastructure theme fizzled out completely. No one talked about the attractiveness of this theme until major announcements and tangible progress were made.

After the outbreak of the COVID-19 pandemic, which originated from China, multinational companies have now slowly begun to diversify their supply chains away from China, and are looking at India as an attractive alternative. This has once again turned the tide in favour of India’s infrastructure theme.

The low borrowing cost is likely to encourage investments from the private sector. The green shoots are already visible, with improvement in private investments and long-term plans made.

How have Infrastructure Funds performed?

Over the last 1 year, infrastructure funds have massively outperformed not only their benchmark but also the broader markets. But strikingly, the 7-year average of infrastructure funds is still lower than the returns generated by Nifty 500.

Table 1: Report Card of Infrastructure Funds

Data as of October 14, 2021
(Source: ACE MF, PersonalFN Research)  

Moreover, the stark difference between the top-performer (Quant Infrastructure Fund) and the bottom-performer (HDFC Infrastructure Fund) over the last 3 years is alarming. This indicates that stock selection has played an important role despite the opportunities in the infrastructure space.

Certain infrastructure funds have also taken active calls and haven’t restricted themselves to companies dominating the Nifty-Infrastructure index. They have been betting big on metals, construction companies, corporate lenders, and power utilities, which of course are part of the broad theme, but are exposed to cyclicality risk.

Besides, there is a very high concentration risk; the top-3 stocks in the Nifty Infrastructure Index account for 43% of the index composition.

A smart way to take exposure to infrastructure and other promising themes

While the infrastructure theme offers an opportunity for wealth creation over the long term, it would be wise to take exposure to schemes that have fair exposure to infrastructure stocks and other sector stocks as well, thus providing you with the required diversification. Invest in diversified equity mutual funds by following a ‘Core & Satellite Investment Strategy‘.

You see, Core & Satellite’ is a time-tested investment strategy followed by some of the most successful equity investors in the world. Given that the Indian equity markets are rising in an unprecedented manner, this strategy would ensure risks and returns are well balanced out.

The term ‘Core’ applies to the more stable, long-term holdings of the portfolio, while the term ‘Satellite’ applies to the strategic portion that would help push up the overall returns of the portfolio, across market conditions.

The ‘Core’ holding should comprise around 65-70% of your equity mutual fund portfolio and consist of a Large-cap Fund, Flexi-cap Fund, and Value Fund/Contra Fund.

The ‘Satellite’ holdings of the portfolio can be around 30-35% comprising of a Mid-cap Fund and an Aggressive Hybrid Fund.

By wisely selecting among these the best mutual fund schemes, structuring your portfolio, and then timely reviewing the Core and Satellite portions and the holdings therein, you would be able to strategically boost your portfolio returns hand-in-hand with the required stability.

[Read: These Mutual Funds Generated Over 100% Returns in the Last One Year. Should You Invest?]

Here are some ground rules to build a mutual fund portfolio following the Core & Satellite approach:

1. Consider funds that have a strong track record of at least 5 years and have been amongst the top performers in their respective categories.
2. The schemes should be diversified across investment styles and fund management.
3. Ensure that each selected scheme abides with its stated objectives, indicated asset allocation, and investment style.
4. You should not only invest across investment styles (such as growth and value), but also across fund houses.
5. The mutual fund schemes should be managed by experienced and competent fund managers and belong to fund houses that have well-defined investment systems and processes in place.
6. Not more than two schemes managed by the same fund manager should be included in the portfolio.
7. Not more than two schemes from the same fund house shall be included in the portfolio.
8. Each scheme that is to be included in the portfolio should have seen an outperformance over three market cycles at least.
9. You should restrict the count of mutual fund schemes in your portfolio to eight.

When the ‘Core & Satellite Investment Strategy is sensibly followed, here are six key benefits it adduces:

1. Facilitates optimal diversification among equity mutual fund schemes
2. Reduces the need to frequently churn your entire portfolio
3. Reduces the risk to your portfolio
4. Enables you to benefit from a variety of investment styles and strategies
5. Creates wealth cushioning the downside
6. Helps you potentially outperform the market

Considering the present market conditions, I suggest taking the Systematic Investment Plan (SIP) route while you build the portfolio of the best equity-oriented mutual fund schemes following the ‘Core and Satellite’ approach.

This article first appeared on PersonalFN here