In this article, we are not going to preach that you should not invest in infrastructure and related funds (haven't we done that many times already?!). So, no preaching here. Only facts. And then, you decide what you want to do with your money.
But before we move further, we wish to share with you the trigger for writing this note. Take a look at the table below:
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By now, you have already understood what we are trying to get at. Never before have we seen so much 'variety', revolving around a particular investment theme -- infrastructure. The innovativeness cannot be overlooked! Full marks to the creativity of the fund houses!
We wondered for a moment what will happen when fund houses run out of innovative names for their infrastructure funds. We quickly realised that some of them have already planned for this. . . . there will be Series 1, Series 2, Series 3 and so on and so forth!! But enough of this. Now, to the facts.
Companies in the Infrastructure sector will grow dramatically
There is an urgent need for not just more, but also better quality infrastructure. And there is no denying the fact that in recent years, there has been some progress in terms of actual investment in the sector. In the years to come, the pace of infrastructure development is only expected to increase. Sure, there will be hiccups, but over the next many years, the sector should definitely log in high rates of growth.
So, the opportunity is out there for companies to benefit from. What you, the investor, should be aware of is that because the opportunity is so good, competition is going to increase. And it already has. Therefore, as the sector grows, there will be some companies that will grow faster than average, and others that will grow a lot slower i.e. not all companies will be meet up with expectations when it comes to the potential growth opportunity in the infrastructure sector.
So, as an investor, you need to be sure that you are invested in the companies which will actually make the most of this opportunity.
Growth will be profitable
There is an implicit assumption that when a company grows, it also makes more profits. Well, we beg to differ. In the infrastructure space, as competition intensifies, margins will thin out, impacting profitability. The road construction business is the best example here.
There will be companies which will also lose money on account of aggressive bidding and/or poor execution. In a recent interaction with a Personalfn client who works in a construction company, we asked what the biggest risk the sector faces today was. Pat came the reply -- execution risk. Yes, there are projects which you can bid for and win. But there is a dearth of skilled manpower to execute these projects. And these days, the penalties are exorbitant. So, the company makes money if it executes well. But if it does not, it stands to lose a packet. And some companies surely will.
So, this is a real risk out there which one needs to keep in mind when evaluating an investment opportunity in the sector.
Growth will lead to higher stock prices
All this while, the growth opportunity has resulted in higher stock prices for infrastructure stocks. But there is an undeniable fact -- ultimately it is earnings growth which drives stock prices. Bagging a huge power project, which will not make you any profits, in the long-term, will not have any positive impact on the stock price of the company. This is a fact.
For instance, roads have been a huge growth opportunity in the last ten years. But then how many of the companies which participated in this actually made money?
In fact, a lot of the better-managed companies have actually exited this business almost completely because it is simply not lucrative enough.
In our view, even if expectations of growth are met, there is no surety that desired profitability will be attained by all companies.
Fund houses are launching Infrastructure funds for your benefit
Investors make money when they buy stocks which are out of favour. Sensible fund managers, who are investing on our behalf, should follow this approach to the hilt. Unfortunately this is not the case.
Launching infrastructure funds, by whatever name called, at the peak of the stock market rally cannot be good for you, the investor. Why launch such funds now? Shouldn't these funds have been launched many years back when the risk reward ratio for investing in the infrastructure sector was in your favour?
Well, here is our take on this -- The infrastructure theme is hot; therefore it is easy to garner monies for the same. And given that all that matters these days is asset size managed by the fund house, well, launching infrastructure funds appears to be one easy route for fund houses to attain it. And size of the mutual fund house does not deliver to you, the investor, any benefit whatsoever.
And here is another thing. Notice that all the infrastructure funds launched so far are close-ended. The reason for that is not probably what one may think -- the fund manager is investing for the long-term and he does not want the risk of interim redemptions..... Here is the real reason, in our view -- until now, only close-ended funds were allowed to charge 6 per cent of the money they mobilise as sales, marketing and distribution expenses i.e. 6 per cent of the money you give to the fund is set aside for marketing the fund (paying to distributors and advertising et cetera)!
So, for every Rs 100 you invest, effectively only Rs 94 is invested. Add to that the annual expenses of the fund and over the term of the investment, you could be at a serious disadvantage.
Why would you invest money in a fund which spends a significant portion of it to grow its assets, for its own benefit?!
The facts are in front of you. You decide whether you should invest your money in infrastructure funds or not!
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