Right since our country achieved independence (in the year 1947); the respective Governments in power have focused on power sector reforms. In 1947, our country had a power generating capacity of 1,362 MW, and today after 65 years of independence we have a total installed capacity of approximately 1,76,990 MW, thus taking us in the top-10 league.
Until we opened the floodgates of our economy in 1991 through the liberalisation process brought in by Dr. Manmohan Singh, the energy sector was dominated by public sector entities. It was only post-liberalisation of our economy that the private sector entities were allowed to participate in this sector (after amending the energy laws). At present even FDI (Foreign Direct Investment) upto 100% is permitted for projects relating to electricity generation, transmission and distribution (other than atomic reactor power plants), without refraining them from any limit on the project cost and quantum of foreign direct investment. All these moves in our opinion were brought in by the Government to fuel power sector reforms in India.
Sailing across all odds and evens!!
Data as on August 16, 2011
(Source: ACE MF, PersonalFN Research)
Even the Indian equity markets recognised this as a positive move, and despite all the scam stories unfolding along with the global economic headwinds taking course; the Indian equity markets since liberalisation (thus far) have delivered a return of +12.0% on CAGR (Compounded Average Growth Rate) basis. Even the BSE Power index which was incepted much later – in the year 2005 has (thus far) delivered a return of 13.1% on CAGR basis. Making hay when the sun shines
To simply put, a sum of 10,000 invested on August 16, 1991 in the BSE Sensex, would have yielded 96,875 as on August 16, 2011, whereas the same sum invested on January 3, 2005 in the BSE Power index (at its inception) would have yielded a sum of 22,628.
Interestingly, during this time when wealth creation was taking place (in midst of scam stories unfolding and intermediate economic turmoil) the mutual fund industry was also mushrooming. Post liberalisation of our economy, the Indian mutual fund was witnessing the entry of private sector enterprises. Even foreign mutual fund houses too were setting up offices in India, along with the industry experiencing several merger and acquisition deals as well. But while all were evincing interest towards the Indian equity markets as well the asset management business; the big question which pops in our minds is – why wasn’t the Indian mutual fund industry focusing on launching energy and power sector theme funds then when power sector reforms were evident? Why were they launching energy and power sector funds only during the exuberant bull run of the Indian equity markets from August 2003 until the U.S. sub-prime mortgage crisis emerged and Lehman Brothers went bankrupt (in 2008)?
|Name of mutual fund scheme ||Inception date ||BSE Sensex ||Price/Earnings of BSE Sensex ||Price/Book Value of BSE Sensex |
|Reliance Diver Power Sector (G) ||May 10, 2004 || 5,555.84 ||18.62 ||3.51 |
|UTI Energy (G) ||December 17, 2007 ||19,261.35 ||26.08 ||6.33 |
|Sundaram-Select Thematic Funds-Energy Opp (G) ||January 3, 2008 ||20,345.20 ||27.91 ||6.77 |
|Reliance Natural Resources (G) ||February 26, 2008 ||17,806.19 ||22.34 ||5.75 |
|DSPBR Natural Res & New Energy (G) ||April 25, 2008 ||17,125.98 ||21.49 ||5.21 |
|Sahara Power & Natural Resources (G) ||June 25, 2008 ||14,220.07 ||17.49 ||3.83 |
|Escorts Power & Energy (G) ||October 20, 2008 ||10,223.09 ||12.75 ||2.66 |
(Source: ACE MF,BSE website, PersonalFN Research)
Well, we found an answer to that. The table above reveals that most fund houses were merely capitalising on positive investor sentiments, until the Lehman Brothers bankruptcy rocked the capital markets across the world. In fact some of these launches were at expensive market levels, where the market (BSE Sensex) Price-to-Equity (P/E) ratio was bloating in the range of 22 to 29 levels.But while the marketing teams of the mutual fund houses did achieve success in garnering more AUM during exuberant times of the Indian equity markets, the performance of energy funds hasn't been very exciting though. How Energy Funds have fared?
(NAV data is as on Aug16, 2011. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period.
free rate is assumed to be 6.37%)
*Note1: Category average has been calculated taking the "simple average" of all the funds in the respective categories.
(Source: ACE MF, PersonalFN Research)
The table above reveals that barring "DSBR Natural Resource & New Energy Fund" (DBNREF), most energy funds have delivered absolutely lacklustre or uninspiring returns across time frames. Over a 3-Yr time frame, energy funds on an average have delivered meagre returns of 4.1% CAGR, thereby underperforming the diversified equity funds following the opportunities style of investing by a considerable margin. Moreover, the category average has not been able to even outperform broader indices such as the BSE-200, BSE Sensex and S&P CNX Nifty. Performance across market cycles
When analysed on their volatility front, barring "Sahara Power & Natural Resources Fund" (SPNRF) most of them have been exposed their investors to low risk (as revealed by their Standard Deviation), but risk-adjusted returns (as revealed by their Sharpe Ratio) generated by them is also quite unappealing. Even SPNRF which has taken high risk hasn't been able to compensate their investors very well for the high risk taken. On the other hand diversified equity funds following the opportunities style of investing have been able manage their risk well and deliver luring risk-adjusted returns for their investors.
(Source: ACE MF,PersonalFN Research)
The study of performance across market cycle reveals that even during the exuberant bull phase (of 2005 to 2008) of the Indian equity markets, energy funds haven't been able deliver any stellar returns. This was mainly due to the fact that most of them were launched during the elevated valuations of the Indian equity markets. When the equity markets witnessed turbulence (from January 2008 to March 2009) due to the global economic crisis they were in fact massacred where all of them eroded wealth of their investors by great magnitude. Yes, even the diversified equity funds following the opportunities style funds did fall; but in the later bull phase of the Indian equity markets they have displayed a smarter recovery and have accentuated on the return front as compared to energy funds which are still paining on the performance front.
Portfolio Characteristics and strategy:
The top-down approach followed by mostenergy funds to predominantly pick stocks in the sector such as power, oil & gas amongst others; closely links their fortune with the performance of these sectors, thus exposingits investors to high sectoral risk.
| Top 10 Stocks |
|Name of the company ||Market cap ||% of holding* |
|Petronet LNG Ltd. ||Large cap ||8.1 |
|Oil & Natural Gas Corpn. Ltd. ||Large cap ||6.3 |
|Cairn India Ltd. ||Large cap ||5.7 |
|Indraprastha Gas Ltd. ||Mid cap ||5.4 |
|Gujarat State Petronet Ltd. ||Mid cap ||5.2 |
|Gujarat Gas Company Ltd. ||Mid cap ||4.9 |
|GAIL (India) Ltd. ||Large cap ||4.8 |
|Reliance Industries Ltd. ||Large cap ||4.5 |
|Bharat Petroleum Corpn. Ltd. ||Large cap ||3.6 |
|Coal India Ltd. ||Large cap ||3.5 || Top 10 sectors |
Note: Sector holdings as on July 31, 2011 of energy funds in the peer comparison
table, have been taken for top-10 sector calculation.
Top 10 stocks are also consolidated of energy funds oriented funds in the peer comparison table
(Source: ACE MF, PersonalFN Research)
But the main reason for the underperformance of these energy funds, is that the companies which they invested in seemed to be all plagued with problems such as fuel availability. Even though the KG Basin discovery has eased worries considerably, supply constraints for domestic companies remain a concern going forward. This in turn has also led to some Indian energy sector companies'look beyond the domestic boundaries for their resources. Moreover, most companies are also facing challenges on the land acquisition and environment clearance issue. The new Bill relating to land acquisition continues to face political opposition, where it provides for acquisition by project development agencies to the extent of 70% of the land required for a project, with the balance to be obtained by the Government.All these factors (amongst others) are leading to delay in project execution, which turn is taking a toll on the performance of the stock prices of energy sector companies and therefore impeding returns.
Energy funds have failed to power their investors' portfolio on the return front. While some have fancied on investing in companies beyond the energy theme, they haven't been able to accentuate their performance. The exuberant launches during their NFO times haveallleddisappointment for investors today. The systemic problems (as seen above) faced by the sector also poses to be riskand hinders capital appreciation.
Mind you, while we are not undermining the potential of the energy sector, we believe that in order to take advantages of the sector, you would be better-off parking your hard earned savings into opportunities style diversified equity funds, as they hold a trait of tapping potential opportunities across themes / sectors and market capitalisation thus elevating their chances of performing better. So far, opportunities style diversified equity funds have outperformed the energy funds, thereby creating wealth for their investors. But remember while you select an opportunities fund in your motive of capital appreciation, it is vital that you select a fund with a consistent track record, and stay invested with an investment horizon of at least 3-5 years. Also the fund selected by you needs to be from a fund house which follows strong investment processes and systems.
This article was written exclusively for Equitymaster, India's leading Independent research initiative. Trusted by over a million members all over the world, Equitymaster is known for its well-researched, unbiased and honest opinions on the Indian Stock Market.