While the power sector has the potential to offer good returns, we advise that you stick to one of the existing power funds from a bigger fund house
Electricity has become the lifeline of our economy. The availability of power determines how fast an economy can grow. To reap the benefits of growth opportunities in the power sector, Escorts Mutual Fund has launched the new fund offer (NFO) of its Power and Energy Fund. This is an open-ended sectoral equity fund that will invest 65-100 per cent of its assets in equity and equity-related securities of companies in the power and energy sector, and the rest 35 per cent in debt instruments. The issue opened on August 25 and will close on September 23. The benchmark for this fund is the BSE Power Index.

Why a power fund
According to Rajesh Sharma, chief investment officer of Escorts Mutual Fund, ?With long-term investments coming in, this sector will grow. Therefore, we are bullish on it. Although investment inflows are less than anticipated, the government is committed to attracting investments, and things will develop over a period of time.?
Adds Prasunjit Mukherjee, a Kolkata-based mutual fund analyst: ?India requires investment worth nearly Rs 6 lakh crore in the power sector. The sector has been thrown open to investments, which are coming in from private companies, including global ones. An investor could make money by investing in it. Valuations have also become reasonable in this sector.?

Present state
The annual GDP growth of the power sector rose from 5.98 per cent in FY07 to 6.27 per cent in FY08, although it has slipped to 5.57 per cent in the March quarter and 2.58 per cent in the June quarter.
The sector comprises several segments such as power generation, transmission, distribution, equipment and technology, trading and power finance companies. The power industry has been characterised by peak power shortages, with demand for electricity exceeding supply by nearly 14 per cent in terms of peak shortage (up to December 2006). By 2011-12, thermal power plants? requirement of gas/LNG, is likely to soar from 40 MMSCMD (million standard cubic metres per day) to 89 MMSCMD.

The major problems faced by the power sector are high transmission and distribution losses, and poor financial condition of state electricity boards.
Says S. Krishnakumar, vice president-equity of Sundaram BNP Paribas AMC, which also has a dedicated Energy Opportunities Fund: ?Power plants are highly capital intensive and require three to six years to move from the drawing board to commissioning. They require a large number of approvals, and tying up of fuel resources.?

Past performance
In two out of last four years, BSE Power Index has outperformed the Sensex. This year (till date) it has given an absolute return of -43 per cent, faring much worse than the Sensex (-28.4 per cent).
For the quarter ended June 2008, the quarter-on-quarter results of companies listed in the power index (aggregate of 14 listed companies) showed a negative change of 13.48 per cent in income and 17 per cent in net profits. The picture is slightly better in case of year-on-year comparisons: income rose 18 per cent while net profits declined by 10 per cent. High commodity prices and high interest rates appear to have taken a toll on the companies in this sector.

The future
The power sector does have potential. According to Sharma of Escorts Mutual Fund, ?Of the total output, the contribution of nuclear energy is less than that of other non-conventional sources. The current nuclear supplies group (NSG) deal will lead to higher contribution from nuclear energy. Moreover, prices of commodities and oil are coming down to reasonable levels the world over. This is likely to lead to a decline in input prices, which will in turn minimise the risk associated with this sector.?

Further, according to Krishnakumar of Sundaram BNP Paribas AMC, ?With the government?s favourable policy initiatives in the areas of fuel linkages, fiscal incentives, big and emerging industrial houses in the private sector have firmed up plans to become major players in this sector.? Feasible capacity addition of about 68,869 MW is expected during 11th Five Year Plan (2007-12).

Should you invest?
Escorts Mutual Fund?s Power and Energy fund will have to compete for the investor?s money against bigger players that have already launched this fund: Reliance Diversified Power Fund, UTI Energy Fund, and Sundaram BNP Paribas Energy Opportunities Fund.
According to mutual fund analyst Mukherjee, ?The fund house is not strong at this moment. Although changes have been incorporated, they may or may not fetch good results. The markets are expected to rebound by the end of the fourth quarter and the sector is expected to reap benefits in about 18-24 months. So, if you decide to invest in this fund, you need to have a long-term investment horizon.?

With power and energy sector funds that have a track record (three years in case of Reliance?s fund) already available from bigger players, investing in the NFO of a smaller fund house would unnecessarily add to the risk of your portfolio. Nonetheless, if you do decide to invest in this fund, since it is a sectoral fund (which are riskier than equity diversified funds), limit your investment upto 5 per cent of the portfolio.