PSUs, are they a really good investment?   Apr 19, 2012

We invest in equity shares and mutual funds with a sole objective of earning superior returns,thereby aiming to earn over and above what we could yield on fixed income instruments. Thus while we aim to do so, we search for companies which indeed focus on maximizing shareholders wealth (by earning luring profits).

But very often many investors also look beyond the ambit of profitability, and invest in companies assuming they are safe. Roaring participation in Initial Public Offers (IPOs) of Public Sector Undertakings (PSUS) is a classic example of this. IPOs of Coal India, NTPC and Power Finance Corporation (PFC)in the past have received an overwhelming response. Coal India received 15.9 lacs of applications (which is the highest number since 2003-04). Likewise PFC got oversubscribed, 76.7 times.

People invested in these companies, since the Government is a majority shareholder. They hooked on the factor of safety, than ascertaining whether they can really maximise shareholders wealth. Getting lured by the pomp in which PSU IPOs hit the market, mutual fund houses too started playing the PSU theme song and they too launched dedicated PSU sector funds, thereby banking on investor's sentiments of treating PSU companies as safe.

While we'll dwell a little deeper to understand whether this faith in the factor of safety has rewarded you, let us understand why in first place, the government holds a controlling stake in companies. The roots lay in the history.

Public Sector Units and Government Ownership

On the onset of independence, India had a huge divide between the poor and rich. India was not self-sufficient in production of goods and services. Majority of the poor masses were illiterate and jobless. In an order to serve the socio-economic objective of conserving the poor's interest and attaining the self-reliant production of goods and services to be able to achieve high and sustainable economic growth; the Government set up industries to build nation's economy. Indian Telephone Industries (ITI) was India's first PSU which was established in 1948 as a pioneer in India's journey in the field of telecommunications. Government went on to establish state owned enterprises in the areas of national interest such as telecommunication, Oil & Gas, Power, Ports etc. It ensured, through five-year plans and various other policy initiatives, the smooth functioning of schemes of national interest. Since then, the PSUs have come long way to establish themselves as some of the most reputed businesses in their respective industries.

Based on their size and profitability PSUs are broadly classified under 4 categories. To be classified under a particular category, the company has to fulfil some predetermined criteria. Moreover, each category has a different level of freedom in running business.

Classification of PSUs
  Maharatna Navaratna Miniratna I Miniratna II
"Basis of Classification" "Avg. annual turnover of minimum Rs 20,000 crore and above for last 3 years & Networth of Minimum Rs 10,000 crore" " Compnaies are rated on efficiancy parameters such as Net profit to Net worth Ratio ,Gross profit to Turnover, EPS , Intersectorial comparison of Net Profit to Net Worth, Gross profit margin to Capital employed, Manpower cost to cost of Production /Services. Companies with the status of Miniratna I and scoring ""excellent"" or Very Good"" in on at least 3 out of 6 parameters mentioned above are granted the status of Navartna" "PSU should have made profits consistantly over last 3 years atleast. The pre tax profit of at least 30 crore in one of those 3 years. Besides, the company should have a positive networth" Should be profitable for last 3 years and should have a positive networth
"Level of Autonomy in Operations" "Can expand operations globally and can take investment decisions upto 15% of their networth or Rs 5,000 Crore whichever is lower,without any government approval" "Can invest upto 15% of their networth or Rs  1,000 crore in a project. They are empowered to spend 30% of their networth in a year without exceeding the ceiling of Rs 1,000 crore. Moreover, they are given the liberty to entre joint ventures, form alliance and float subsidiaries abroad." "Can entre into joint ventures, set subsidiary companies and offices overseas with some applied conditions. " "Have liberty of incurring the capital expenditure upto 50% of their networth or Rs 300 crore whichever is lower; without any govt. approval."
Some popular PSUs Coal India, NTPC, ONGC Bharat Heavy Electricals Ltd., Bharat Petroleum Corporation Ltd. ,Power Fianance Corp ltd. Airports Authority of India, BSNL Ltd.,Engineers India Ltd. HMT (International) Ltd., Bharat Pumps & Comressors Ltd., PEC Ltd.

(Source: Department of Public Enterprise, PersonalFN Research)

Table above reveals that the companies with "Mahartna" status are well established businesses which enjoy greater autonomy in operations. However, the autonomy decreases as we come down the hierarchy. Status of "Miniratna II" gives the company the autonomy to take decisions only in respect of incurring capital expenditure. Also, it would be clear from the illustrative list of companies that the full autonomy has not been conferred to any of the PSUs since they come from the sectors of national interest. Further, the level of autonomy too defers from company to company depending on its size efficiency and more importantly the level of social responsibility it has to shoulder.

Although the PSU companies have some non-commercial objectives to achieve, they are expected to run professionally and generate profits to be able to sustain growth. Government of India, with a view of letting citizens to benefit from the growth of PSUs, began divesting its stake in PSUs. This was in line with the provisions of New Economic Policy (1991) which supported the process of liberalisation; Government began divesting its stake in PSUs. Videsh Sanchar Nigam Ltd. (VSNL) was the first PSU to go public in 1999-2000. Over the span of last 12 years, Government has divested its stake in various PSUs aggregating to Rs 80,840 crore. And as on March 31, 2012, PSUs accounted for about 26% of the total market capitalisation of companies listed on Bombay Stock Exchange (BSE).

How has BSE PSU fared vis-à-vis BSE 200

Base: Rs 10,000
Data as on April 13, 2012
(Source: ACE MF; PersonalFN Research)

But interestingly, the graph above reveals that the broader index - BSE-200, has performed better than the BSE PSU over last few years. Thus even if one were to invest Rs 10,000 each in the BSE PSU and BSE-200 a decade ago (i.e. on April 13, 2002), it would have a yielded a sum of Rs 45,487 and Rs 51,768 respectively as on April 13, 2012.

Performance across Market Cycles
BSE PSU 41.2% -51.0% 63.5% -22.8%
BSE-200 51.6% -59.0% 84.4% -14.3%

NAV as on April 13, 2012.Returns over 1-Yr are compounded annualised
(Source: ACE MF, PersonalFN Research)

Likewise speaking about the performance of PSU stocks during the bull, bear and corrective phases of the Indian equity markets, the table above reveals that during two bull phases cited above BSE PSU stocks have under performed in comparison to the BSE-200. However during the last bear phase (occurred due to rippling effect of the U.S. sub-prime mortgage crisis), BSE PSU stocks have managed the downside risk far better when compared to BSE-200. But having said that, the present corrective phase, the BSE PSU stocks have plunged far more in comparison to BSE-200.

This study of performance across market cycles thus makes us draw conclusions contradictory to a common notion that investment in PSUs is safe.

After having examined how PSUs as a category perform against the broader market index; let's us evaluate, whether dedicated mutual fund schemes which had a mandate to invest in PSU sector, did live-up to the pomp, and indeed provide safety to you investors.

Performance of PSU Sector Funds
Scheme Name 1 Year (%) 2 Years (%) Date of Inception SI (%)
Religare PSU Equity (G) -12.6 -2.2 18-Nov-09 -1.4
Sundaram PSU Opp (G) -14.7 0.0 11-Jan-10 -3.5
SBI PSU (G) -17.0 - 7-Jul-10 -10.2
Baroda Pioneer PSU Equity (G) -19.7 - 4-Oct-10 -18.8
BSE PSU -19.6 -9.8 - -
BSE-200 -11.1 -2.0 - -

NAV as on April 13, 2012.Returns over 1-Yr are compounded annualised, SI: Since Inception
(Source: ACE MF; PersonalFN Research)

The table above reveal that returns generated by the respective funds have been nothing to vie for. In fact there they eroded your hard-earned money invested.

Religare Mutual Fund was the first fund house to launch a PSU fund in November 2009. Within a span of 1 year since then, 3 other fund houses launched funds focusing on PSUs. A closer study of the timing of launch reveals that the respective fund houses attempted to match the aggressive fund-raising programme of the Government through divestment of its stake in PSUs. In 2009-10, the PSUs garnered about Rs 31,081crore, recording the highest ever fund-raising by PSUs.At present, Government has been running high fiscal deficits for a last few years and to bridge the gap between its revenue and expenditure; they have used disinvestment as an avenue of fund-raising.

It is noteworthy that investing in PSU sector funds generally exposes you to a risk of sector concentration.

Component "others" is comprised of Miscellaneous, Capital Goods, Transport Services, Agriculture and Telecom
(Source: ACE MF, PersonalFN Research)

The chart exhibited above depicts that top 4 sectors constitute around 88% of BSE PSU index. And there too, you have a concentration of material and commodity related sectors such as Oil & Gas and Metals & mining which are cyclical in nature. They usually perform well when the world economy especially the developing nations such as China, Brazil, India are doing well on the economic growth front.

Arguments in favour of investing in PSUs:

It is often argued that PSU companies are fundamentally sound and have a strong ownership pattern, give that Government of India being the single largest shareholder. They often operate in businesses which have high entry barriers making them, in a way niche and of their own kind. For example, Coal India; it is a single largest producer of Coal in the world which commands around 74% of the Indian Coal Market. Another point that is considered as a merit of investing in PSUs is the authenticity of the enterprise as the Government of India holds the controlling stake. Furthermore, accounts of PSUs are audited by Comptroller and Auditor General of India (CAG) which also heads the Indian Audit and Accounts Department, giving assurance of best quality operations in accounting of PSUs. It is a known fact that the Indian Government has a long list of profitable and well managed PSUs which have not yet gone public. This adds to the list of reasons why one should go whole hog on buying PSU stocks or mutual funds focusing on PSUs.

But the other side...
Though the controlling stake of the Government in PSUs is expected to boost the confidence of investors in the managements; the recent history leaves investors with hundreds of questions. It often mars the business potential of the company. So called "Political compulsions" make politicians take difficult decisions. However, in reality politicians often treat PSUs as their own demesnes and bend company managements to take commercially unviable decisions to enshroud the shortcomings of the Government. On numerous occasions Government has "used" PSU banks and insurance giant LIC to entre commercially unviable deals. Although the managements of the concerned PSUs have repetitively denied any interference of the Government in the business operations, it has become an open secret these days.

Our View

We are of the view that although the Government holds the controlling stake in the PSUs (which could be a strong argument in favour of investing in them), the nature of control by the Government in PSUs has always been questionable. While many get lured by the support which these companies have from the Government, in our view it need not be criteria for it being safe. For example, when PSU banks fall short of funds and their capital adequacy goes down below the comfort level; Government pumps in money. These would be difficult for a private bank to get such a preferential treatment. True but one should not forget how the PSU banks are persuaded to enter deals which may raise many questions. Coal India is has nearly a monopoly in its business in India and has huge cash on its books. But the moot question is,why Coal India despite having thousands of crore rupees of cash on its books; does not have the autonomy to deploying it? Recently Coal India got a Presedential directive forcing it to sign a Long Term Fuel Supply Agreements with power generating companies.

Government has done nothing wrong in directing Coal India to enter this pact; was a much needed move to counter the power deficit in the country. But while doing so, Government has shown apathy to minority shareholders of Coal India. Why to make such companies public? Coal India went public through a blockbuster IPO in October 2010. In October 2010 Government was very well aware of the shortage of raw material supply (Coal) in the power generation business. In August 2009, the Government divested its stake in hydro power generation company, NHPC. The issue was very aggressively priced and stock, even after 2 ½ years of its listing, trades at almost 50% below its offer price today.

Such indents make us believe that the Government is, at times, no different from those promoters who don't care for the retail investors. Even after considering the difficult role it has to play in balancing the interest of shareholders and that of the people of India, the functioning of PSUs leave a lot of room for improvement.

As far as investing in these companies goes, be it directly or through dedicated mutual funds, decision should be made on case specific basis. Some PSUs have an envious performance record and even big institutional investors, both domestic and global, acknowledge it by investing a huge chunk in them. However, you don't need a dedicated fund to benefit from opportunities in the PSU sector. Holding diversified equity funds can do well for your portfolio.

Diversified Equity Funds Vs. BSE 200
Scheme Name 1 Year (%) 2 Years (%) 3 Years (%) 5 Years (%) 7 Years (%) 10 Years (%) Std. Dev Sharpe Ratio
Category Avg. of Diversified Equity Funds -7.7 19.9 7.2 22.6 0.4 16.8 7.09 0.22
BSE-200 -11.1 -2.0 16.8 5.9 14.2 18.0 7.92 0.19

NAV as on April 13, 2012.Returns over 1-Yr are compounded annualised
* category average is a simple average of returns generate by 62 diversified equity funds classified as large cap, multi cap, flexi cap and opportunities style funds. Only primary schemes are considered.
(Source: ACE MF, PersonalFN Research)

The table above reveals that category of diversified equity mutual funds has outperformed BSE 200, which in turn has outperformed BSE PSU by a noticeable margin over all critical milestones. Moreover, they have been less volatile and have managed to generate superior risk-adjusted returns as denoted by the superior Sharpe Ratio. It is noteworthy that, fund managers of these diversified mutual funds have also invested in some PSUs but purely on merits of the companies and not just by following the theme.

One should not underestimate the reach and the return potential of a diversified mutual fund. However, the selection of a right mutual fund scheme holds the key. What you just saw above is the collective performance of all diversified equity funds. For example, over last 3 years and 5 years, the difference in the returns of the category toppers and the one at the bottom has been 18.3% and 26.9% respectively. Investors would be better-off in being watchful about the mutual fund schemes they invest into. All fancy fads fade with time.

Add Comments

May 11, 2012

Bart: What makes you believe it's a joke?James: Based on my meteruemsnas from the pictures my best estimate of the width was about 15 inches. Notably smaller than the 19 inch standard rack size, but definitely too wide to allow two side by side in a single rack (half-width rack mount servers are not uncommon)I guess that they have their own rack style that supports ~15 inch wide servers. For the number of servers that they run it would not be difficult to get unique racks manufactured. Probably no-one manufactures racks that fit well in a shipping container anyway.
Oct 15, 2013

I hope you can enhance the article by adding the new scheme introduced by HDFC named, flexi index fund. through this, you can start sip on selected debt or liquid fund and set 4 targets based on index level to auto transfer your money to index funds when sensex reaching to the target level. the four level work like this. If current level is 14k, you starting SIP now and setting first goal, trigger 25% to index fund when reaching to 12k. Trigger another 25% if it reaching to 10k, trigger whole amount when it reaching to 7K. This seems a good option but need to know the performance of debt fund to start SIP on it. Hope you will research on this and add another arcltie on this blog.