What has contributed to the spectacular performance of this fund?
A number of factors actually. The bullish market has helped. The power sector in general has performed well. To move to specifics, our disciplined approach. We have been very focused. This fund boasts of a very high-quality and stable portfolio. We have picked up stocks doing our own research. The Torrent Power stock has been an eight bagger for us. Kirloskar Brothers, Jindal Steel & Power, Jaiprakash Associates and Areva T&D India are stocks that we bought much ahead and at times where there was no external research on those stocks available. A lot of in-house research has gone into stock selection. We have had our share of misses. We booked profits in some stocks a little too early. Power Grid, Power Finance and BHEL are some examples. But that does not worry us. It is part and parcel of the game.
The performance is very noticeable. But what index are you benchmarked against? Is it available in the public domain?
Since this is a sector fund, it obviously has to be benchmarked against a relevant index. Today, we have the BSE Power Index. But when we launched this fund a few years ago, there was no benchmark index. Since an index is mandatory for a mutual fund, we requested IISL*, a joint venture between NSE* and CRISIL* to create a specific one for us. So we are benchmarked against the India Power Index which has been created and is maintained by them.
What is the strategic and tactical orientation of the Power Sector Fund?
We have flexibility to be fully invested in equity or debt or even cash. We do not have any market capitalisation bias. The mandate is that we can invest in any power-related companies. Be it power generation, transmission or utilities and even power equipment companies. We can also invest in companies that are predominantly exposed to the power sector.
Can you give some examples of such companies exposed to the power sector?
Jindal Steel and Power, where the bulk of its valuation comes from the power business. This has been the same with Jai Prakash Associates where a major part of its valuation comes from the power construction business. We also have energy companies like ONGC.
How do construction companies like Subhash Projects & Marketing fit in your portfolio? Subhash Projects has a significant presence in rural electrification. Punj Lloyd is venturing into power construction. Kirloskar Brothers manufactures pumps used in the power sector.
In the offer document, it is clearly mentioned that minimum 65 per cent would be in power and power related companies. So we have the liberty of going up to 35 per cent in other companies that are not related to power. Of course, though we have the leeway, we have dissuaded ourselves from exercising this option unnecessarily. ICICI Bank was an exception because when we picked it up, it had crashed to such a level that it made a good buy. Fortunately, we had the cash at that time to make that buy. So it was more of a trading call.
You seem to have a significant cash component in this fund.
We do not have a restriction in this fund. In all our sector funds the cash levels tend to be very erratic. And in the past one year, the cash levels in this fund have been high. The reason being that money has been coming in. And secondly, we are totally dispassionate about booking profits in each sharp surge in the market. So we book profits and exit and then try to re-enter later at a lower level.
Have you ever exercised the mandate of being totally in cash or debt?
Only during the initial months. We launched in May 2004. That was the election year. There was a lot of euphoria. The Sensex was at 6,000 and we were very concerned about valuations. So we invested not more than 20 per cent of the portfolio in the initial four months. And that paid off handsomely. When the markets crashed by around 30-35 per cent, this fund barely fell.
Do you forsee going fully into cash again?
We are such a large fund now that it is impossible to be fully in cash. Our corpus is around Rs 4,400 crore. Having said that, we always use cash as a portfolio item and will use it effectively to enhance returns and reduce risk and volatility. When the Sensex was at 20,000, we were around 30-35 per cent in cash.
With so much of flexibility, do you plan to make your fund a more concentrated offering? It is fairly diversified. And the highest holding, Reliance Energy, accounts for only 7.69 per cent of the portfolio.
In none of our diversified funds do we have an exposure to a single stock crossing 7 per cent. For sector funds, we go up to a maximum of 8-9 per cent. We have always been careful of too much exposure to one single stock.
Actually, 2004 was the worst year for power companies. When the new government came in, the biggest concern was whether or not the government would go ahead with the reforms. Power stocks were hammered. They crashed by around 30-50 per cent. The portfolio was quite concentrated in the earlier days but we still had a decent quantity of power sector exposure. In the initial years, we concentrated more on the equipment companies. It is only in the past one year that we have increased our exposure to generation and utilities. As the economy keeps progressing, more and more players are coming into the sector and are getting listed. There have so many IPOs over the past two to three years - NTPC, Power Grid, Power Finance, PTC India, Lanco Infratech, GVK Power and Infrastructure, and GMR. And this is what the trend is going to be in the future too. NHPC, NTPC, Rural Electrification, North East Electric Corporation and Damodar Valley Corporation are all waiting to tap the market.
What is your view of the power sector?
It took 60 years for the economy to reach a trillion dollars. But it will take only 6 years for the economy to double. Or probably less, if the rupee keeps appreciating. Similarly, for the power sector, it took 60 years to reach the capacity it is at today. But it will double in the next six to seven years. If you look at the sector globally, it is huge. In India it is just evolving.
What's driving this sector?
Tremendous demand. India already has a power shortage. And at the rate the economy is growing, the increase in the levels of income, the increase in the number of malls and multiplexes, the power requirement is only going to rise.
All said and done, if the economy is to grow, it needs power. Look at the last three to four elections on the state side, provision of electricity has been a big issue. Politicians are realising that the aspirations of people are on the rise. And unless you provide the basic infrastructure there will be a lot of hue and cry. So what happened on the road front will happen on the power front. We are already seeing it.
Capital is more easily available; both in terms of debt and equity. So the execution risk which always existed in the power sector is no longer there. Earlier power companies had to depend on foreign capital for the capacity to come into place. Now companies like Reliance Energy, Tata Power, NTPC and newer companies like Adani Power, GVK Power Infrastructure, GMR, are all so aggressive and have the capital raising ability to execute their projects. There is going to be a huge demand from the equipment side and a lot of reforms from the distribution and transmission side. Everyone is looking at how much money is to be spent on power generation. But more than that will be spent on revamping distribution, transmission and enhancing capacity.
Do you feel there is any particular segment of the power industry that will go ahead of the others?
No. I feel that from here on they will all perform in tandem. Opportunities exist everywhere. The initial beneficiaries were the equipment companies because there was revamping of the entire state and central infrastructure. But now with generation companies coming to the fore, the entire sector will grow significantly.
Are you not concerned about the slow pace of reforms in the sector?
We launched four sector funds between 2001 and 2005: pharma, media, banking and power. We believe that these four sectors will continue to grow for the next 10 years. We did not want to launch a sector fund which will be the flavour for only two-three years. All these sectors have ample fundamental traits in them to grow at a decent pace over the next 10 years.
There were setbacks. The change in government in 2004 slowed down the process in the initial period. Then the Enron controversy put off a lot of foreign companies which exited the country. But overall the demand for power meant that there would always be space for entrepreneurs who would set up capacities. That is what we have been seeing over the past few years. Plants for 500MW have been coming up gradually. Now that is accelerating. The government's renewed resolve to set up power capacities is clearly evident with the Ultra Mega Power Plant strategies and fuel linkages. Utilities, if implemented properly, are the best businesses. For the next 30 to 40 years you are assured of a particular rate of return irrespective if the economy grows at 8 per cent or 30 per cent.
What reform would you like to see in the immediate future?
There is still a bit of control on the distribution side. The distribution, except in a few cities, is under the control of state undertakings. That is the cause of a lot of leakages. Distribution losses are largely due to theft, mismanagement and faulty metering, some also in connivance with staff of organisations. But change is happening. Mumbai, Ahmedabad, Surat, Delhi, Kolkata, Orissa are already privatised. MSEB has given distribution in Bhiwandi to Torrent Power. So such experiments will start in a lot of other cities.
What are the challenges you see in this sector?
Basically valuations. They are not cheap. So to buy stocks now is that much harder than it was a few years ago. Of course, opportunities keep coming up. The market corrected from 20,000 to 18,000 in three days. This in itself was a great chance to pick some stocks. Manpower is another concern faced by such companies and all companies in the infrastructure space. You need engineers to implement projects. The execution costs of implementing a project are going to rise. The third is fuel linkages. Thermal power projects would need sufficient amount of coal to fuel those projects.
* NSE: National Stock Exchange
* CRISIL: Credit Rating & Information Services India Ltd.
* IISL: India Index Services & Products Ltd.
This interview appeared in December 2007 Issue of Wealth Insight.