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MFs bet on engineering stocks

July 06, 2005 13:30 IST

Theoretically speaking, investors in diversified equity funds should enjoy high diversification levels. Unlike a sector fund, wherein limited investment options are available; the fund manager handling a diversified equity fund has the liberty to invest in a variety of stocks across sectors. However the present investment scenario seems to suggest that fund managers are doing the contrary.

We have observed that the engineering sector has emerged as a preferred investment avenue for a large number of funds. The engineering sector comprises of companies like ABB, L&T, Siemens among others. Funds have been going overweight in this sector at risk of losing the diversification edge. 

Gung ho on engineering!
Schemes Holding (%)
(Original data sourced from fact sheets, holdings as on May 31, 2005)
The adjacent table lists funds with the most concentrated holdings in the engineering sector. However some clarifications are necessary here. For the purpose of computing sectoral allocations, like-natured sectors have been clubbed. For example, holdings in the engineering sector above are a compilation of investments in related sectors like industrial capital goods, electrical equipment, and industrial conglomerates among others. The above method of calculation reveals the fund's accurate diversification levels or lack of it.

As can be seen in the table, the penchant for stocks from the engineering sector is prevalent across fund houses. Even tax-saving funds i.e. Magnum Taxgain (38.21 per cent), HDFC Long Term Advantage (31.00 per cent) and HDFC Tax Saver (28.07 per cent) haven't shied away from taking sectoral bets. The strength of the sector's lure can be understood by the fact that even a traditionally conservative fund house like Sundaram Mutual is all set to launch a new fund that is dedicated to sectors which benefit from capex.

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    So what makes the engineering sector so lucrative and are the lop-sided investments justified? As per, there are the 2 key reasons why investors have been lapping up stocks from the engineering sector.

    Deregulation benefits in the power sector
    Power sector contributes the largest to the engineering companies' revenues. For instance, ABB and BHEL derive 60 per cent and 69 per cent 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 we have been 'consistent' in missing our 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 medium term growth of these companies.

    Government's increased focus on infrastructure development
    Infrastructure is another key area of operation for major Indian engineering companies. In the recent budget, the government had outlined an investment of Rs 10,000 crore (about $2.3 billion), 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 per cent in the long-term, we need to raise infrastructure spending to around 10 per cent of GDP, or $50 billion per year! If this were to happen, investors in engineering stocks will have more reasons to cheer. states, "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".

    Now that we know about the sector's prospects, let's find out what the concentrated holdings mean for mutual fund investors. From an investor's perspective, a sectorally concentrated portfolio enhances the risk associated with the investment.

    While one could read the same as the fund manager's confidence or an opportunity to cash in on a lucrative investment proposition, it nevertheless exposes the investor to higher risk levels. Allocations in the 25-35 per cent range in a single sector can expose the fund to high levels of turbulence, should the sector experience a change in fortune.

    It is imperative for investors to be better informed about how their investments are being managed. The fact sheet reveals a significant amount of information pertaining to the fund; study the same on a regular basis.

    Keep an eye on any significant deviations in the fund's performance or its portfolio. Seek expert advice from your investment advisor. The key lies in being aware and making studied decisions.

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