New wave of reforms started in India way back in 1991, when the Government in power then decided to open up the economy through various policy initiatives such as deregulation, privatisation and reforms in international trade policies (which were aimed to achieve sustainable and higher economic growth rate.

Through integrated efforts, for the first time post-independence, India achieved the growth rate of around 9%. However, it was clear that to sustain such higher economic growth, India needed an overhaul in its infrastructure. This was because despite an up-tick in economic growth rate, India’s infrastructure remained one of the least developed among some major economies of the world.

Even after 14 years of reforms, in 2005, India not only lagged the developed nations but scored miserably even when compared to other developing economies such as Brazil and China on the infrastructure development and its usage, on some of the vital infra parameters.

Infrastructure development Indicators

Infrastructure	USA	UK	France	Germany	China	Brazil	India
Electric Power consumption (kWh, per capita)	13,694	6,252	7,677	7,113	1,783	0.15	476
Air Transport (Registered Carrier departures)*	9,969,599	1,018,118	728,081	1,023,858	1,349,269	514,700	330,484
Container Port Traffic**	34,299,572	5,986,582	4,490,583	12,765,326	105,976,701	6,246,096	7,888,990

(* Both Domestic and international take-offs; **Port container traffic measures the flow of containers from land to sea transport modes)
(Data as on the end of calendar year 2005)
(Source: World Bank)

 

Some of the key challenges faced on the infrastructure development were:

• Lower budgetary allocation and expenditure toward the infra space
• Constrains in procuring financing (for infrastructure development)
• Impediments in obtaining approvals and delays in awarding contracts
• Poor private participation

Lack of tax incentivesBut later, in the Union Budget of 2005, the then Finance Minister (FM) acknowledged the problems of poor infrastructure development. It was well recognised that India needed significant improvements in infrastructure without which the growth rate of 8%+ would be unsustainable. In order to augment the infrastructure development; government proposed to enhance the budgetary support and stimulate private participation in Infrastructure financing. Attempts were made to catalyse growth by strengthening regulatory framework and providing much needed support to some of key infrastructure sectors.

 

On the onset of the second round of reforms, some of Indian mutual funds sensed the investment opportunity in various sectors of infrastructure such as power, roads, ports, irrigation and infra financing and launched infrastructure thematic funds in 2005-2006. But if we assess their performance today, it has been a mixed bag and not very luring. While the Indian economy was on an exuberant bull run since August 2005, until the U.S. sub-prime mortgage crisis emerged in the U.S in January 2008, fund houses focused on garnering more Assets Under Management (AUM) vide infra funds, and the performance too was quite eye catching. But during the bear cycle steered by the U.S. sub-prime mortgage crisis and the Lehman Brother bankruptcy, these funds were hammered substantially, and even today while the Indian equity markets have displayed a smart economic recovery, these funds have faltered on the performance front as RBI adopted anti-inflationary monetary policy stance – which in turn affected the underlying stocks of respective funds as high interest cost pinched their over-leverage balanced sheets.

How CNX Infrastructure has fared against some major indices

(Source: BSE,NSE, PersonalFN Research)

 

The above graph reveals that if you were to invest a sum of Rs 100 in the CNX infrastructure index on August 01, 2005 your money would have appreciated to Rs 158 (CAGR Return of 7.8%) as on September 28, 2011, whereas a similar investment in BSE 200 index would have more than doubled – yielding you Rs 207 (CAGR Return of 12.4%) and in S&P CNX Nifty Rs 214 (CAGR Return of 13.1%). It is also clear from the graph above that the infrastructure sector was the major gainer in the exuberant bull run of the Indian equity markets from August 2005, until the U.S. sub-prime mortgage emerged in the U.S. in 2008. But when the U.S. sub-prime mortgage crisis emerged it lost its way during the market mayhem and failed to gain the highs of its glory days again.

  Performance across market cycles

(Source: ACE MF, PersonalFN Research)

 

Deteriorating fundamentals of many companies, changing macro-economic conditions have affected the investors’ sentiment negatively. Moreover, companies in the infra space are reeling under pressures and are impacted by the following factors:

 

• Rising interest rates
• Highly leveraged balance sheets
• Working capital management problems
• Slower execution of projects
• Delays in resource procurement
• Intense competition

Hence, the study of performance across market cycles also exhibits a dismal performance (of 9.0%) of the CNX Infrastructure Index during the recovery phase (after the U.S. sub-prime mortgage crisis and Lehman Brother bankruptcy) as against the luring performance of the BSE 200 index and S&P CNX Nifty Index.

How have infra Funds fared?

Note: Category average of infra funds is the simple average of the funds in the peer table above, while that of opportunities funds is the simple average of all opportunities style diversified equity funds.

(NAV data as on September 28, 2011. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period. Risk-free rate is assumed to be at 6.37%)
(Source: ACE MF, PersonalFN Research)

 

Thus even as far as performance of infrastructure funds is concerned, they haven’t delivered very appealing returns. In fact fund houses following strong investment processes and systems too have delivered lacklustre returns as their portfolios felt the turbulence of sub-prime mortgage crisis in the U.S., Lehman Brothers bankruptcy and anti-inflationary monetary policy stance adopted by RBI. However interestingly while all these events did occur in the last 3 years, opportunities style diversified equity funds managed to sail well across time frame as their fluid investment style permitted it to take opportunities across sectors and market capitalisation, which thus enabled them to deliver luring risk adjusted returns (as revealed by their Sharpe Ratio), as compared to infra funds which exposed their investors to average risk (as revealed by their Standard Deviation) but generated abysmal risk-adjusted returns.

 

It is noteworthy that growing emphasis on the infrastructure development and the euphoria generated during the exuberant bull phase – prior to sub-prime mortgage crisis and Lehman Brothers bankruptcy made infrastructure a favourite theme in the year 2005. Many key sectors in infra such as construction and power, witnessed tremendous upsurge in activity as companies chalked out aggressive expansion plans, and investors too gave an overwhelming response to the capital raising plans of these companies. Holding some of these sectors and stocks therein Infrastructure funds certainly generated ecstatic returns during 2006 and early 2008, but later these same stocks were hammered during the downside of the Indian equity markets (from January 9, 2008 until March 9, 2009)

Some popular stocks held by infra funds in August 2005

(Portfolio as on August 31, 2011 Source ACE MF: Personal FN Research)

 

(Source: BSE, NSE, Personal FN Research)

 

For instance, stocks such as Bharat Earth Movers Limited (BEML) - one of the major players in manufacturing of mining and construction equipment and which supplies to nearly half the total market in India; was spotted in the portfolio of most infra funds experienced a humongous rally prior to the crisis, but now seems to faltering to generate wealth for investors.

 

(Source: BSE, NSE, Personal FN Research)

 

The story of Gammon India Limited - one of the largest civil engineering construction companies in India, was no different. Despite having to its credit some the key projects such as India’s first cable stayed bridge built in Sikkim, Asia’s longest railway tunnel in Maharashtra; the stock has performed awfully.

The Road ahead & verdict

We recognise the fact that infrastructure need in India is clearly outpacing the supply. Infrastructure deficit has been glaring and impeding India’s growth story. And to sustain the high growth rate (of above 8%), India has to show remarkable improvements in the quality of infrastructure. According to World Economic Forum, “India requires infrastructure investment of $1 trillion over five years starting in April 2012 as it aims to boost economic growth to 10%”. This in our opinion will certainly provide an impetus to the infra theme (which at present reeling under pressures of high interest cost due their over leveraged balance sheets).

 

But we believe in order to take opportunities emerging in the infra theme, diversified equity funds following opportunities style of investing would enable to even out sector or theme specific risk well due to their fluid investment style and their trait of investing across market capitalisations and sectors. Moreover, you would also get the opportunity to be a part of other promising themes such as consumption and banking, which a sole infra fund may preclude you from.

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.

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Comments
mattos@bbcr.com.br Jan 19, 2012 This forum needed shaking up and you've just done that. Great post!
i2skipatrol@gmail.com Nov 03, 2011 This is exactly what I was looking for. Thanks for writing!

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