Securities and Exchange Board of India (SEBI) has been encouraging mutual funds to protect the interest of unit holders (who are otherwise the minority shareholders) in companies they invest in. They are being encouraged to exercise their voting rights effectively as and when needed. However, doing so in case of companies operating as Public Sector Undertakings (PSUs) may be a big challenge for mutual funds. A number of mutual funds invest in PSUs. After all, top 50 listed PSUs form about 15% of the total market capitalisation as per government records as on July 31, 2013. PSUs operate in some crucial sectors such as Oil and Gas and Banking to name a few and thus it is difficult to find a diversified fund not investing in atleast some PSUs. Moreover, there are some dedicated thematic funds investing only in PSUs. Investments made over last couple of years in these companies would have made huge losses.
 

Underperformance of PSUs

(Data as on August 05, 2013)
(Source: ACE MF, PersonalFN research)  

Over last 2 years, S&P BSE PSU Index lost about 36% of its value at the time when S&P BSE Sensex registered gains of 11% on absolute basis. A closer look suggests that PSU index has been losing massive ground since the beginning of the year 2013.

Here’s why?
There are largely two factors that have affected the performance of S&P BSE PSU Index. Like many private sector companies, even PSUs are affected with the current lull in the economy. Those operating in power and capital goods have been impacted the most. PSU banks are struggling to maintain asset quality. They are facing challenges to keep Non Performing Assets (NPAs) low. However, the primary reason for poor stock market performance of PSUs is issues pertaining to governance. Investors have showed low confidence in state owned companies as, more often than not, the government has been treating them as cash cows.

Today, India faces a problem of high fiscal deficit and current account deficit. While current account deficit may be corrected by reducing net imports, shoring up revenues and containing expenditure helps curtail fiscal deficit. In an attempt to raise revenues, the government has been nagging PSUs for higher dividends. The companies pay dividends through their earned profits. Although profits and profitability of PSUs has come under pressure, their dividend payouts seem to have been not affected at all. In fact, dividend payout as a percentage of overall profit has been constantly rising since Financial Year (FY) 2010-11. This means, companies are retaining lesser profits. Excess funds with stronger PSU companies are often diverted to restructure weaker PSUs and meet fiscal deficits. Going one step forward, this year government asked PSUs to buy its shares in other companies in case they had no big capex plans. Such practices are affecting sentiment of non-government investors which is reflected in the relentless fall in stock prices of public sector companies over last couple of years.

PersonalFN believes that carnage of PSU stocks has also affected the performance of mutual funds investing in them. PSU dedicated funds bore the maximum brunt since they had no option but to invest. PersonalFN has always discouraged investors from investing in sectorial and thematic funds for this very reason. In spite of knowing weaknesses of the underlying theme or the sector; sector and thematic funds continue to take exposure to them as they are mandated to do so. In view of PersonalFN, investors should invest in diversified mutual funds. Meticulous selection process helps you identify a winning mutual fund.

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