While the state of infrastructure in this country has always presented a phenomenal potential to make big bucks, it was the government’s planned infrastructure expenditure of $320 billion during the eleventh 5-year plan (2007-2012) that did the trick. Even if half of it materialises, infrastructure funds will be able to generate great returns. Little wonder that infrastructure was not even recognised as a separate theme a few years ago.

Last calendar year, infrastructure funds shot to prominence by topping the performance rankings.

Among the five best performing diversified equity funds, three were infrastructure funds. The podium looked impressive for the theme. UTI Infrastructure came in with top honours, followed by Tata Infrastructure at third place and ICICI Prudential’s flagship Infrastructure fund in fourth place. UTI Infrastructure, the undisputed trendsetter was the first to grab the opportunity in April 2004. Talk about early bird getting the worm, it managed its illustrious performance with an astounding 61.5% return through 2006. Tata Infrastructure and ICICI Prudential Infrastructure were not far behind, delivering 60.32% and 58.53% respectively. This was no mean feat considering that in 2005, not a single infrastructure fund featured in the top 10 return generators.

More importantly, the canvas has become vast for investors and they can currently pick one of 12 such infrastructure dedicated funds. So from a conservative fund to a highly aggressive one, from one that sticks to large caps to one that leans towards smaller companies, there is an infrastructure fund to suit every investor profile.

Defining theme

One aspect that we tend to be wary of is funds with loosely defined investment mandates. And this ambiguity is most prevalent amongst infrastructure funds. There is no clear cut definition as to which sectors make up the infrastructure theme. Each fund house will have its own definition of infrastructure stocks. Take DSPML TIGER, which stands for ‘The Infrastructure Growth and Economic Reforms’ fund. The fund focuses on sectors that are likely to prosper from growth related to economic reforms and infrastructure development. In spite of the different definitions, at a very fundamental level, these funds invest in capital goods and engineering companies. So ABB, Bharat Heavy Electronics Ltd, Greaves Cotton, Jyoti Structures, Larsen & Toubro, Punj Lloyd, Suzlon, Lakshmi Machine Works and Gammon India will be the prototypes. But the theme can be extended to encompass cement, construction, refining and even telecom stocks.

As of August 31, CanInfrastructure dedicated 5.3% of its assets under management (AUM) to telecommunication giants Bharti Airtel and Reliance Communications. Similarly, Tata Infrastructure’s combined allocation to these two stocks amounts to an impressive 8.16%. Real estate stocks too have found their way to these portfolios. DLF figures in the portfolio of Can Infrastructure. JM HI FI bought Peninsula Land in December 2006, Ansal Properties and Infrastructure in May 2007 and added Housing Development and Infrastructure in July 2007.

What does appear startling are banking and pharma companies in an infrastructure fund. The logic? Financial institutions like HDFC and IDFC and almost all banks lend to the infrastructure sector. DSPML TIGER invested heavily in HDFC and until recently the stock figured in the top three holdings of the fund house (as per the June portfolio).

Diversified lot

Here you will find funds on both ends of the spectrum. Some have as many as 70 stocks in their portfolio while others are content with 20-odd. Tata Infrastructure has a huge collection of 66 stocks which is down from 70 (February 2007). But JM HI FI has turned on the aggression with an 80% allocation to mid- and small-caps. Perhaps this aggression was the reason the fund fell over 18% in the first quarter of 2007, much more than its peers. Compare that with DSPML TIGER, which fell only 3.76% during that time. A diversified portfolio of 60 stocks with half of them in large caps is what saved the day for the TIGER. Then again funds such as ICICI Prudential Infrastructure have been playing in derivatives in a big way. As per the July 2007 portfolio, the fund had around 12% of its assets in Nifty Futures, a steady rise from February this year when the figure was 7.87%. As of now the fund has toned this down to just below 5%.

What to expect

After the stock market’s steep fall in February-March, the fastest to recover were capital goods stocks. Since they constitute the bulk of such portfolios, the returns of infrastructure funds got a boost.

The BSE Capital Goods index rose 14.6% in April and rose further by 10% in the month of May as well as June. Between April 2 and September 17, the index rose by 58.96%. On the other hand, the Sensex generated less than half of that at 24.48% during the identical period. Among other sectoral indices, BSE Metal delivered 47.71%, BSE Oil and Gas 35.64% while BSE Bankex returned 31.5%. As a result, with capital goods, oil and metal stocks dominating such portfolios, these funds benefited. On the flip side, a higher sector concentration, which is a characteristic feature of theme funds, goes against the very grain of a diversified portfolio. And its implications can be disastrous. For instance, the March 2007 quarter was dismal for all infrastructure funds that were overweight on the construction sector.

Hitherto these funds have found themselves invested in the right sector at the right time; but in equity markets the tables can turn before you can say Jack Robinson. So far this year the going looks good for these funds with most of them on track with the category of diversified equity. However, their performance might not be as good as the previous year because several construction, real estate and basic engineering stocks now command very high valuations. Though infrastructure will remain a powerful theme, investors should tone down expectations.

DSPML TIGER: Broad minded

Unlike other infrastructure offerings, its broader mandate has enabled it to tap into sectors that core infrastructure funds do not – healthcare, FMCG, textiles.

The portfolio too is well diversified and this year averaged at around 65 stocks. RIL, the largest holding, is currently at less than 6% and the rest are all below 4%. One can expect such diversification from a mid-cap fund, but this is surprising from a predominantly large-cap offering. Nevertheless, its tilt towards growth investing has enabled it to deliver superior returns. The rankings, as on September 17, show the fund in a very favourable light. And considering its broad investment mandate, it won’t run out of good ideas. This fund should keep rolling for a while.

ICICI Prudential Infrastructure: It’s different

There exist discernible characteristics in the fund’s portfolio that set it apart from other infrastructure based funds. Get this: the fund’s average exposure to basic and engineering stocks over the past one year has been only 8.7%. Compare this to the fact that the average infrastructure fund holds at least 20% of its assets in the basic and engineering sector.

Another stark difference is that the fund is underweight on construction stocks relative to its peers – something that not many infrastructure funds would tinker with. The fund has managed to strike equilibrium between making contra bets and limiting its downside by maintaining smaller holdings. This balancing act has worked in its favour as it displays better resilience in a bear market. A relatively less volatile performance and an optimally diversified portfolio make the fund a good pick.

Tata Infrastructure: Smooth operator

The real clincher here has been the fund manager’s ability to spot sector trends. For instance, before the markets tanked in May 2006, the fund manager had cut back his exposure to financial services. The move was profitable because the sector was amongst the biggest losers in the bear phase that ensued. By February 2007, the fund manager re-entered the sector, timing the entry rather well, because through the June 2007 quarter this sector delivered phenomenal returns. Similarly, the fund’s timing in the metal sector was flawless. These two significant calls have translated into a 23.3% return in the June 2007 quarter compared to the category’s 16.88% return. But the strategy has its share of pitfalls too.

The March 2007 quarter was disastrous, for the fund lost 8.26% compared to the category’s loss of 5.93%. The main reason for this slip up was the 24% exposure to the construction sector. The fund also shows a tendency to slip faster in a falling market. In a nutshell, the fund is definitely not for nervy investors.

UTI Infrastructure: First among equals

The fund has managed to stay ahead of the category, despite hitting a rough patch in the first quarter. Like many other infrastructure funds, UTI Infrastructure also burnt its fingers in the construction space, losing close to 9% in the March 2007 quarter compared to the category’s loss of (-) 5.93%. Although historically, the fund has fairly spread its assets across stocks of different market caps, of late it has developed a bias for large-caps. At the end of August 2007, stocks of large companies accounted for 60.5% of its assets, compared to 40% a year ago.

As far as the sector allocation is concerned, the fund is not too adventurous and sticks to the large consensus sectors of basic engineering, construction and energy. This one is an interesting proposition for those who want to bet on the capex wave sweeping the country.

?The author is CEO, Value Research