The Mutual Fund Show: Is Now A Good Time To Invest In Infrastructure Funds?
Scaffolding surrounds a new terminal building at the Allahabad Airport in now Prayagraj, Uttar Pradesh. (Photographer: Prashanth Vishwanathan/Bloomberg)

The Mutual Fund Show: Is Now A Good Time To Invest In Infrastructure Funds?

With the government focusing more on infrastructure in this year’s budget, is it a good time to invest in infrastructure funds?

Yes, according to Sunil Subramaniam, managing director and chief executive officer of Sundaram Asset Management Company, who said there’s money to be made, provided one gets entry and exit right. Therefore, determining accurate timing becomes crucial, he said in this week’s The Mutual Fund Show.

Infrastructure stocks have returned 2-3% gains to investors over the last 10 years, according to calculations by Sundaram Mutual Fund. But according to an analysis by Subramaniam, the Indian economy has witnessed “virtuous” and “vicious” cycles over the last 17 years. Small-cap and mid-cap companies, he said, perform better than their large-cap counterparts during virtuous cycles because the proportion of cyclical sectors like infrastructure is relatively higher in the smaller market capitalisation space.

The Mutual Fund Show: Is Now A Good Time To Invest In Infrastructure Funds?

The three factors that will drive the virtuous business cycle now are housing, the national infrastructure pipeline and production-linked incentive schemes, he said. Anyone must approach these investments tactically, with the mindset of exiting once their money is doubled over the next 3-5 years, he said.

Tarun Birani, founder and director of TBNG Advisors, disagreed. People are better off investing in diversified mutual funds as they’d also capture the infrastructure theme, he said. Birani also spoke about schemes that his fund house is recommending to clients and the reasons behind it.

Watch the show to know more

Edited excerpts of the conversation:

At the outset, let me ask you, are you on the throes of launching an infrastructure fund?

SUNIL SUBRAMANIAM: No, but we already have a well-established infrastructure fund.

My primary question to you is this, we’ve seen a number of false starts, what is your thought this time around?

SUNIL SUBRAMANIAM: Basically there’s a story of the boy who cried wolf. Every time, he’d say that the wolf is coming and it didn’t come but then one fine day, it arrived. People tend to say, ‘arre,nahi hua, nahi hua’  (It didn’t happen, it didn’t happen) and then, they miss it. So, my point here is, I feel that the odds are very much in favour of infra being the biggest wealth creator over the next 5-to-10-year period and I think it’s a very sustainable story. But unfortunately, we’ve seen lots of false dawns as I call it. So, the first was there was a big capex boom in 2011-12, when India was just coming out of the 2008 crisis. There was a lot of capex done by the government and everybody, everybody bought infra funds, and then the crash happened and they lost money. Then Mr. Modi came to power, again Mr. Modi’s main thrust was infrastructure, roads everything, he put in a lot of effort, and you see again the 2014-2017 period, good infra work was done and Infra Mutual Funds went up but then the economy went into a tailspin, and then the Covid crisis came and gave it a big slap. So again, infra fell down.

Now, what happens is that, again, there are green shoots happening and a lot of stuff happening, but this time I believe that there is the ability and it starts with Mr. Modi having absolute majority in both houses of parliament, which was not the case earlier. That’s number one. Number two is that the crisis has given us an opportunity because during the crisis, what I liked about the way the government handled it, in terms of the budget being an Infra-capex one, is that the government didn’t shy away from expanding fiscal deficit or using it in the right place for Infra. I think that’s where the seriousness of the story gets a second and then there’s the china plus one which we will dwell into later. Today, my confidence level is for the Infra sector mutual funds, which are probably the best wealth creation sectors within the mutual fund space over the next 5-10 years. I’m keen to go and tell investors don’t go by your past returns, right now they don’t look great, but this is the place to be. Don’t go by the past times that the promises were not delivered, this time I believe there’s a reasonable chance, and I’d like to use this to ask you to please allocate some sector of your equity allocations into infrastructure mutual funds. That’s my pitch and I thought that I should come and say this when people asking why and not why not, because two years from now, the returns will be so fantastic, then they’ll start jumping in but they may have missed the early part of the ride. The early bird gets the worm, is very true for this kind of space. That’s my thesis. We can dwell in a little more detail as we go through the presentation.

Can I request you to start off with this very interesting set of data points that you’ve given, which show that the buy and hold strategy in infra mutual funds or the infra space doesn’t work, and therefore timing it is very crucial and is that the reason why you believe that now is the time because traditionally, people are bad at timing things. Therefore, it’s very important to kind of get that straight.

SUNIL SUBRAMANIAM: And as mutual fund manufacturers we keep telling people, don’t time the market, but not in this case. That’s the reason we did a rolling returns analysis of the NSE infra index. From April 2004 to today, so 17 years. What is rolling returns analysis? Every day you make an investment, whether for one-year, three-years, five-years or 10-years and see what happens to it. For example, there are almost 6,000 data points for a one-year return, and you have almost 2500 data points for a 10 year return. So, this gives you the average, the maximum or the minimum, there’s a solidity to this type of an analysis. What it is telling you is that if you blindly stayed for a 10-year period, the average return will go up by either 2% or in five years 3%. Why? Because it’s cyclical, because very often you enter in the wrong time of the cycle and exit at the wrong time. So, the point we are trying to make here through this, is that if you get your timing right you can make as much as 34% per annum over a five-year period, which is the time frame I’m talking about now. So, if you don’t get your timing right you could make huge losses. The timing is right, and the probability of getting that is also a function of the timing. If you see here, the probability and where do you put your money in equity as this is high-risk equity mind you, to beat inflation? In the last line, as you can see on an average you only do 20-29%. You beat the inflation, that is, you got 7% plus returns but if you get your timing right, that could be 75-80% in terms of timing. So, unlike a normal diversified mutual fund, simply buying and holding in infra doesn’t work as your timing of entry and timing of exit are both crucial. If you do that, you can have a lot of multi-bagger returns in your portfolio.

Is what happened in the budget a harbinger of things to come, so to say, you reckon because the same government has been there for a while, why is it that you believe that this is the time to do so?

SUNIL SUBRAMANIAM: There are three reasons for that. First is that this is the government doing what it wanted to do but couldn’t succeed. Now, why I believe that they can succeed? As I said, a majority in both houses of parliament, the crisis is an opportunity, so they can push through these tough things, but the most important thing is the China factor because what is infrastructure? People tend to think of airports, ports, roads, railways, the overall infrastructure but an infrastructure mutual fund is not going to go and invest in an airport project. It is not going to make money for you by investing in a road project. It’s going to make money by investing in companies benefiting from the infrastructure. So, when you then define the infrastructure this way, you can say that anything that creates the demand. What happens when you build a road or an airport? You need cement, you need steel, you need building materials but what happens when you build an individual house? You need cement, you need steel and you need building materials. So, the infra space is a feeder of multiple thought processes, and the three things that are driving this confidence is, the housing sector. Why? Interest rates are at an all-time low, 6.7%, property prices have been stable and incomes of people have risen. So, 10 years ago, it costed 50% of a person’s EMI as a proportion of his salary. Today that is down to 29%. So, it’s never been cheaper to buy a house. In fact, it’s also a very good time because just with 3%more money from your pocket every month, you can actually rent a house, take advantage of the tax benefit and build it. So, we believed that along with the government’s Aadhar housing project and all of those things, housing will be a big driver of the infrastructure space, that’s number one.

Number two is the national infrastructure pipeline. Rs 111 lakh crores is the outlay over five years, that the government is going to do this. Now, all this money is not going to come from the government. They’re going to tap sovereign wealth funds, they’ve created a lot of tax incentives with it. They’re going to tap a lot of other resources; they’re creating a new development bank in the budget—The Development Finance Bank. So, we believe that the government’s thrust on infrastructure this time carries more teeth and the budget was a reinforcement of that because they’ve created it. The third thing is that the China plus one opportunity. I will come to the China plus one opportunity probably later but the key is, financing this has to come from FDIs and that’s where a number of reforms that the government has taken in opening up FDIs—in defence, in railways and in insurance. It has opened up in a number of sectors. It has opened up the public sector to the private sector, where again foreigners can participate. So, FDI coming in and when foreigners come in, the beauty of this whole theme was that normally you say infrastructure has to cater to the domestic market. You build something domestic but with the FDI route, what happens is that India can become the manufacturing capital which plays China. So these FDIs which will come in, I believe will be export oriented FDIs. So, it will give a boost to exports, but they’re going to come in and setting up factories and what has this government already done to support that? They’ve reduced the corporate tax rate from 35%to 17% unbelievably, that’s two years back and this is now comparable to Singapore. Singapore and India are the cheapest in terms of tax rates in the world for a foreigner. The second is, all the infrastructure work that the government has already done, the licenses they have created, the FDI limits—means that in ease of doing business, India’s ranking has improved 79 places over the last five years. So, a foreigner looking at India five years ago to now, there’s a world of difference. I believe that the confidence comes to me, because India’s FDI chart has been rising. You’re getting $50-60 billion a year but that’s coming mostly into the private equity, internet, startups like Swiggy, and Zomato. I think we need to just divert that into the manufacturing space and you have probably and potentially $100 billion a year of foreigners financing the capex story. I think that’s the reason I get a confidence, and then, for this FDI to come in, who’s going to come in? The people who are currently manufacturing in China. Now, why should they come from China? I’m not talking about Trump’s tariff wars, yes, the Covid crisis originating from China means that a lot of foreigners have got a little wary of China but that’s a small factor but important.

The core factor is something that is called structural advantage for India. What is the structural advantage? The structural advantage is our youth population. As you know, India has an average age of 28years but that’s not it. 2017 is a hallmark year though it’s about a few years back, I’d like to use it as a starting point. 2017 is the year, when a very important thing took place. China’s labour population, because they implemented a one family one child policy and the population started declining. From 2017 onwards, China’s population has begun a declining trend because they’re not producing enough new babies. India has not adopted any such family planning. The unbelievable thing is in the decade, 2017 to 2027, India is going to add117 million people to the workforce while China is losing 23 million people from their workforce. The next biggest country to supply labour into the population is Indonesia at 17 million. Hence, I am not worried. The British have us good education which we have built on in terms of Pharma and IT and others. This slide tells you that with those skills and availability, whether it is financial attractiveness through the tax rates or it is the business environment or ease of doing business—India has shown such a strong improvement that India already looks like being one of the most globally attractive companies for manufacturing to come in. What we believe is that, more and more foreign multinationals are going to be looking at the China plus one strategy. It’s not that they’re going to stop manufacturing in China but China’s per capita income, thanks to their success over the last decade or 15 years, their income is close to $10,000 per capita. India is $2,000. Why do I point this out? I am pointing this out because our labour is five times cheaper than China. So, A, the supply of labour, B, the cost of labour means that foreigners who are in the competing markets who need to reduce every cost, are going to look at diversifying their production facility away from China and India has to be in the pole position there with all these steps and the final step is a three-letter word. It’s called PLI, production linked incentive, targeted directly at the foreign people who are manufacturing in China. What is this? Any factory which is set up in specified 13-14 identified industries, the value additions that they bring—if you pull out iron ore from the ground, that’s not going to count. What do you make that iron ore into—means iron ore into steel and steel into a car, that has a 5-6% of value addition for five years, the government is going to put power into those companies as an incentive, so there’s an advantage. Hence, I believe that in the electronic side you’re seeing all the Samsungs and the Apples manufacturing doing well. That’s my reason why I believe that this time, it’s not a false dawn, because I believe that all these factors are coming together. The final argument here, in a way to put it across is the fact that the FII money coming into India, if you analyse it and separate out the hedge funds from the pension funds, you will see that the component of sovereign wealth funds, pension funds and long-term money is much higher, and why, because they see this potential translating into ETFs in the Indian companies’ corporate sector and translating into value.

Would you believe, therefore that sectoral thematic infra funds would give the bigger bang for the buck as opposed to diversified mutual funds? I know both could be good but I’m asking you that if, indeed, you’re choosing to say that this time is different and the reasons are not just housing and infrastructure, but also PLI and also other factors, then would you believe that diversified mutual funds could give equally good returns or carefully chosen infrastructure thematic funds could probably give a better alpha between two categories?

SUNIL SUBRAMANIAM: I think the second is true, that the diversified mutual fund that fund which would obviously have an allocation to infra because they know this story but as a smart investor, if you can, time your exit right, that is the key here because in diversified mutual funds, the fund manager plans the exit. That’s why they say buy and hold, because if infra stops being a flavour, 5 years or 10 years down the road, and something else is the flavour then, the fund manager takes the switch. So how do you judge this? It’s basically the business cycles. I believe that starting from March, our economy has turned into a new virtuous business cycle which is ultimately something that infrastructure related sectors are all very cyclical. I think that if you look at the bounce, I would like to take 2003 to 2008, which was one of the strongest bull cycles that we’d seen which I believe we are now set to see. At that time, you had something like 55% per annum returns from small cap funds, from infra funds. As you can see here on the graph, India has been through multiple cycles within 2003-2008. 2008 to 2013 was a bad cycle with the global financial crisis. Again, 2013 to 2017 with the Modi regime, the first half was a good cycle. Then in 2017, we started the downturn with all the crises and now from March again. So, when you look at this virtuous-vicious cycle, what happens is that, cyclical things like the small cap or the infra do much better than a safety oriented large cap kind of a thing in a virtuous cycle and the opposite is true in a vicious cycle. If you sense a vicious cycle on the way, that’s the time to pull your money out.

Now as a normal investor, how do you know when to pull your money out? There are two ways to approach this. One is the economic signals are there in terms of valuations, if valuations reach very high, that means that the market is over-promising the future. Today if you see the valuation chart, I believe we are still way off the peak valuations of the infra sector in 2008—which was the last very big peak, number one. Number two is with such an ambitious goal, normally you’d expect10-15% return from your normal diversified mutual fund. That’s what you expect, nominal GDP plus a little bit of alpha, plus 25% return per annum and let’s say you have a rule of 72, which is, at 25%, you will double your money in three years. What I am saying is this, set yourself a target that I want to double my money, arguably in three to five years, you will double it, and then I am saying, ruthlessly exit when you have doubled the money, don’t get greedy. Don’t think that now that it’s double, can it be quadruple? Can I hang on a little bit more? No, I said if you take that kind of an approach, walk off with whatever you’ve made. After that, if you have lost, you have lost, but at least you have made money. So, set that goal to yourself right at the beginning when the time is right. I’m sure the goal will be achieved if not in three years, maybe in three and a half years, mostly in five. Even if the doubling happens in five, you’ve still made 15% per annum returns. My suggestion is that choose it that way. It’s a wealth creating sector, set your goals ambitiously, but when those goals have reached, ruthlessly exit. That’s the best way for a lay investor to play a cyclical sectoral cycle.

I want a brief view from you on infra before we move on to the topics that we discuss every show. But first, a view on infrastructure funds, they’ve promised a lot in the past and failed to deliver. Do you believe that this time around could be different? Why or why not?

TARUN BIRANI: I have a very different view, I feel investing based on suitability is one of the most important part it is not something one can jump in if it is like herd mentality moving in the markets. I have observed that the infrastructure sectors in the past have not been a wealth creating sector and normally when we look at long term investors, we don’t want anybody to tactically keep on moving in and moving out. So, we did a rolling return research across 10-year plus infra funds available in the market as well as the category. To my surprise, there has been almost 26% of the times one should be prepared for negative returns with a five-year horizon in that study. That tells me, why can’t I live without an infra fund and whether my fund manager in a either a diversified large cap or a mid-cap or a multi-cap fund takes a tactical call in an infra fund. That would be a better way. I continue to believe there is a strong momentum going on for infrastructure. I was listening to Mr. Subramaniam also that there are a lot of positive things which are happening in the infrastructure sector as we speak in our country and this could definitely lead to a lot of positives but at the same time looking at the track record in the past, it doesn’t give me a lot of confidence and I feel the risk reward ratio looking at the past historical track record, doesn’t look that attractive to me. So, I would rather play the infrastructure story through a means of a diversified fund rather than a sector specific infrastructure fund.

Tarun, I think you’ve chosen the Kotak Emerging Equity Fund, which is apparently one of the best performing mid-cap funds. Can you talk a bit about this fund and if people have this fund what should they do and if they don’t have it, what should they do. Then, of course, if you can also give us a sense of the category.

TARUN BIRANI: You asked me to select a category and to select the fund. So, while doing that exercise, I thought of a category called mid-cap, where I see in terms of valuation compared to a large-cap or a blue-chip category continues to look more attractive to me. I see a possibility of getting better returns in this available sector. So, in the mid and small-cap strategy one needs to be very careful in terms of the risk portion. The risk will be comparatively much higher compared to a blue chip or a large-cap category but while observing this category what I did, as an exercise was, I selected all funds with a 10-year plus track record and in that 10-year track record the top five six names which came across, I tried doing some analysis on that. My analysis was mainly focused around two factors. One was a quantitative and the other was a qualitative factor. While doing the quantitative analysis, I looked at various factors like trailing returns, I looked at rolling returns and I looked at downside capture ratio. While doing all these exercises, what I feel right now is, the momentum is strong, and in the next 5 to 10 years you could see greater returns coming from this category. So, I would like to go for a fund which can capture the highest upside in the coming years. That is what I am looking at. Again, you can see that this Kotak Emerging Fund has delivered almost 21% times more returns between 15-20% and it has delivered almost 48% times. So, 48.6% times, it has given more than 20% returns. So, that again gives you a lot of confidence the kind of risk you are taking, the rewards are also handsome. What I liked again, was the team which is managing this fund has a good track record for almost a decade and they are continuously managing this fund. So, they have been doing it with a purpose, they have been doing it very smartly too. That is also one positive thing.

Again, the diversification since you can go wrong with the mid-cap strategy too, you need to be much more diversified compared to a blue-chip strategy. This fund has maintained that diversification and they end up taking almost 40 plus stocks in the portfolio. So that is again a positive which I like, the risk management of this fund is very good. As we speak, currently they are also bullish more on the cyclical and in the infra-oriented theme and almost 45% of the portfolio is positioned there. So, I would like to play the mid-cap strategy with this kind of a structure, that is my argument. The process flow is good, the people flow is good, risk management is good and the performance has been good too. The upside capture ratio is good and in terms of downside, we looked into last year when the Covid crisis happened, the mid-cap category was down almost 40%, this was down 30%. So again, the downside capture is good in this fund.

Now comes the key question about what is it that TPNG Capital Advisors is advising their clients to do, and out of the plethora of funds that they may be advocating, what is that one standout fund at the current point of time. Why so, and what kind of people can apply or can invest in that fund. I presume you are recommending the Parag Parikh Flexi Cap Fund. Why this one and what kind of investors can apply to this?

TARUN BIRANI: We were trying to understand in the environment where we are currently in. What kind of strategies can win and in that we reviewed a lot of strategies which are India-only centric strategies versus strategies which have the flexibility to go outside India too. So, under that strategy we came across this fund called Parag Parikh Long Term Equity Fund, and which is renamed as Flexi Cap Fund. The good part about this strategy is they have almost 30% of their allocation outside India, which I think in the last three-four years, has captured the imaginations of Indians that there needs to be allocation outside India, there are so many good companies outside India, where as an investor why should I look only at India? Keeping that in mind, we felt a global kind of an allocation really adds and brings more diversification. When you look at this fund’s downside allocation, we did this analysis for the last five years. The downside protection is just 40% compared to the average downside which is at 70-75% for most of the other funds.

What does that mean, Tarun?

TARUN BIRANI: This means that when the market goes down by 10%, it goes down only by 4%. So that gives you a lot of protection in the downside. At the same time, it has an upside capture ratio of almost 75% which again gives you a power that if the market goes up by 10, it will go up by 7½ % plus. Again, this fund, under its mandate, it can go all-out in India also. While talking to that fund house, we realised that they only have one scheme in the overall platter. They don’t have like 30 or 40 schemes, so that I think gives you a lot of confidence as that focuses much more in this kind of category. Again, they have been very contrarian investors. I have seen them in 2018, taking some amount of defensive calls also because they were not comfortable with the valuation at that point of time. So, they are ready to take contrarian calls too. They picked up a stock called ITC Ltd. when nobody was looking at it at 150- 160 rupees. But at that point of time the dividend yield was attractive, their hospitality business too as most of the pain in that sector was over for them. That’s why they looked at that as a value stock and today as we speak, that stock is up 50% from that level. Yes, the entire market is up but I like the way they look at capturing the low P/E stocks or value stocks in their portfolio. So that is another good thing. They can be compared to Maruti in India and as in terms of valuation, they’re like Suzuki. So, all these reasons gives me a lot of confidence. The ‘why’ as an investor, do I need to be restricted only to India? I need to look at investment opportunities across the globe. Why should I restrict myself?

Any risk factors very quickly in the Kotak fund or in the Parag Parikh?

TARUN BIRANI: So, from a suitability point of view if you don’t have a five-year plus horizon, please don’t look at equity investment and you need to be aware that last year, equity as a strategy for some point of time has delivered 30-40% negative returns. If you don’t have the guts to bear that kind of a loss, don’t get into equity. Don’t get into paper loss and paper profit kind of a concept. Plant it like a tree, keep watering it and only then, you can generate long term wealth creation.

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