Infra Theme - With 3-5-yr horizon will find it rewarding

Infrastructure was touted as the most happening sector in 2008. Every big fund house launched an infrastructure fund, and investors were more than happy to pour money into them. But now, three years later, it is a different story. Infrastructure funds are languishing at the bottom in terms of returns and many disappointed investors are pulling out money from these schemes. The CNX infrastructure index has slipped 21.3% in the past year compared to an 11.6% fall in the Nifty. While Reliance Infrastructure Fund has lost 39%, most other funds have lost more than 20% over the past year.

THE GROUND REALITY

The infra segment has been going through a rough patch for the past 18 months due to several reasons. Primary amongst them are issues related to land acquisition and an increase in project costs and higher working capital.

Land acquisition continues at a snail's pace, posing problems for several infrastructure projects. In the power sector, there are delays in payments by state electricity boards, especially to power generating companies. Last but not the least, costs of raw material such as coal have increased and there are issues regarding their availability. All this has severe repercussions for any infrastructure project. Project costs across power, roads are going haywire and companies need higher working capital. Infrastructure projects are extremely capital intensive. If companies need more money to manage their working capital, they will have to borrow more. This pushes up their interest costs and affects their margins. Funding is another issue for infrastructure projects. Banks generally don't fund projects with very long gestation periods. The interest rate cycle is on an uptick, adding to infrastructure companies woes. The central bank, in an attempt to control inflation, has raised interest rates 10 times since March 2010. "The cost of finance is the major problem for infrastructure projects. The cost of funds is too high and makes many infrastructure projects unviable. Finally, the infrastructure segment, to a large extent, depends on spending from the government as well as its policies. Over the past year, the government, beleaguered by many issues, has been slow in rolling out infrastructure projects. A crucial bill relating to land acquisition is still stuck. This has led to a delay in sanctioning and closure of new projects in the infrastructure space.

IS THERE A WAY OUT?

Infra funds have been underperforming the broader indices for three years. As per data available with Valuersearchonline.com, which tracks the mutual fund industry, while the universe of infrastructure funds returned 2.45% per annum, the Nifty returned 4.15% per annum. Worse, many experts believe the immediate future of these funds don't look bright. In the short term, there could be more downside," says Vishal Dhawan, founder, Plan Ahead Wealth Advisors.

However, many still swear by the theme. Their argument is simple: For the India story to roll on, infrastructure building is a must. The country can't do without a robust infrastructure if it has to grow the GDP at 8%. Be it roads, ports, water, power or metro rail systems, all of these are crucial to support growth.

Good infrastructure is a basic support system of the economy and is needed to facilitate high growth rates. Hence, it is imperative that the government resolves issues relating to infrastructure growth.

Secondly, the cost of funds, a major input for the sector, may come down soon.
The cost of finance is the major problem for infrastructure projects. We need a situation where we can finance projects easily. Many now believe that the interest rates are close to their peak levels.

As of now, there are indications that there may be at best one more rate hike before the central bank pauses. Clearly, if rate hikes slow down, companies in the sector will heave a sigh of relief.

SO WHAT SHOULD YOU DO?

Investors in these funds are disappointed. Infrastructure funds have severely underperformed for three years, with many investors losing 20%-40% of their money in the past year alone. However, many experts don't want you to exit these schemes, as they believe they can deliver in the long term. There is no point in exiting your investments at this point at a loss when the future is bright. Long-term investors should stay put. Investors should realise that though investment in infrastructure starts early, returns often come in late but at a faster rate and, hence, investors must be patient and have a 3-5-year time horizon while investing in such funds.

New investors should first figure out if sectoral funds, especially infrastructure funds, will meet your requirements. Sectoral funds carry high risks and are meant for individuals with a higher-risk appetite. Investment advisors do not recommend such funds to investors with a low-risk appetite. Unlike in a diversified equity fund, where the fund manager takes a call, in a sectoral fund, an investor should be in a position to understand or assess the fundamentals of the sector before choosing one. Invest not more than 10% of your portfolio in sectoral funds. Those with a low-risk appetite may consider large-cap diversified equity fund.

Finally, if you have decided to invest in the infrastructure theme, you need to screen the fund portfolios carefully before selecting your fund. Be sure, that it follows the infrastructure theme and is in line with your objectives before you commit your money. Do not commit money in one go, invest in phases over a six-month period, using a SIP.

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