Sundaram Capital Expenditure Opportunities Fund (SCEF) is a medium to high risk investment proposition. The fund will invest in sectors that are ancillary to the infrastructure sector. These are the 'feeder' industries that provide materials to the infrastructure sector. With such an investment strategy, we would have been tempted to brand SCEF an out and out sector fund, but for some measures on the fund's part to diversify across non-related industries. The fund's investment strategy allows the fund manager to invest in non-capital goods industries to the extent of 30% (maximum) of net assets. This makes us classify the fund as a medium to high risk investment proposition.
In our view, while the fund's rationale for investing in capital goods industries is sound given the opportunity, devoting three-fourths of the fund's assets to just one theme works against diversification. Moreover, diversified equity fund managers are also likely to identify growth opportunities in the capital goods sector and invest accordingly. If you are already invested across a few diversified equity funds, there is a good chance that most of them already have 'healthy' allocations to the capital goods sector. This is what we concluded going by a recent study on allocations to the capital goods sector.
Moreover, this is the first sector-specific fund from Sundaram Mutual Fund. While its diversified equity funds have performed reasonably well over the years, it does not have a track record to speak of in the 'sector funds' space.
With regards to the opportunity in the infrastructure sector (which will drive growth in the capital goods sector) we have a short note on the same prepared by our sister portal Equitymaster.com
1. Deregulation benefits in the power sector:
Power sector contributes the largest to the engineering companies' revenues. For instance, ABB and BHEL derive 60% and 69% of their revenues from supplying equipments to the power sector. And with the government clearing the blueprint for adding 100,000 MW in the tenth (2002-07) and eleventh (2007-12) five-year plans, the potential seems high for the engineering majors. Investors however, need to practice caution on this account, as the country has been 'consistent' in missing its targets of generation capacity additions in the past. For instance, while China, with a capacity of 380,000 MW adds around 30,000-40,000 MW per annum, the Indian power sector's average is just around 3,500-4,000 MW! Also, valuations factor in the growth prospects over the next two years adequately.
2. Government's increased focus on infrastructure development:
In the recent budget, the government had outlined an investment of Rs 100 bn (US$ 2.3 bn), through a special purpose vehicle, to finance infrastructure development in the country. While this is a step in the right direction, the corpus of investment outlined is not enough to match the growing needs of a developing country like India. In order to sustain a growth of 6%-7% in the long-term, we need to raise infrastructure spending to around 10% of GDP, or US$ 50 bn per year! If this were to happen, investors in engineering stocks will have more reasons to cheer.
"While the above factors enthuse us to be buoyant on the Indian engineering and power companies, the same is not without its share of concerns. These include global slowdown, uncertainty about global commodity prices (inputs for companies), intensifying competition with new global entrants, and above all, the interference of politics in economics that has slowed down progress in the past".
"Another factor for investors to consider is the fact that valuations of large and mid-size companies are already factoring in a lot of their future potential. So any investment in this sector has to be a long gestation one to benefit from this opportunity".
