Fund Focus: HDFC Infrastructure Fund

Could this be the right fund in the right theme at the right time?

Srinivas Rao Ravuri, Fund Manager - Equities, HDFC AMC

HDFC Infrastructure Fund remained a pure infra play through the rough times in CY15 and CY16 when infra asset creators and financers underperformed. Remaining true to label is now paying off, with the Government's recent announcements around highways and bank recap likely to provide a big fillip to infra asset creators and financers. Could this therefore be a case of right fund in the right theme at the right time for those who want to take either a tactical bet or a satellite allocation?

What do percentiles and their colours signify?

Fund performance is typically measured against benchmark (alpha) and against competition. Performance versus competition is measured through percentile scores - ie, what percentage of funds in the same category did this fund beat in the particular period?

If a fund's rank in a year was 6/25 it means that it stood 6th among a total of 25 funds in that category, in that period. This means 5 funds did better than this fund. In percentile terms, it stood at the 80th percentile - which means 20% of funds did better than this fund, in that particular period. If, in the next year, its rank was 11/26, it means 10 other funds out of a universe of 26 did better than this fund - or 38% of funds did better than this one. Its percentile score is therefore 62% - which signifies it beat 62% of competition.

Most fund managers aim to be in the top quartile (75 percentile or higher) while second quartile is also an acceptable outcome (beating 50 to 75% of competition). What is generally not acceptable is to be in the 3rd or 4th quartiles (beating less than 50% of competition). Accordingly, we have given colour codes aligned with how fund houses see their own percentile scores. Green colour signifies top quartile (percentile score of 75 and above), yellow or amber signifies second quartile (percentile scores of 50 to 74) and red signifies 3rd and 4th quartile performance. A simple visual inspection of colour codes can thus give you an idea of how often this fund has been in the top half of the table and how often it slips to the bottom half. A great fund performance is one which has only greens and yellows and no reds - admittedly a tall ask!

WF: The fund underperformed benchmark (Nifty 500) and its peer set (infrastructure sector funds) in 2015 and 2016 before bouncing back on a YTD basis in CY17. What are the factors that contributed to the underperformance and how have you steered the fund back into positive alpha zone?

Srinivas: The fund has a significant overweight to corporate banks as against other infrastructure funds and the NIFTY 500. Corporate banks had been laggards in 2016 on account of the NPA issues and concerns of haircuts to existing large loan accounts.

We believe that the government, RBI and the banks have been proactively working on resolving the NPA issues plaguing the banking system. Therefore, in our opinion, the NPA cycle has peaked and with regards to the existing pool of NPA`s, banks have been aggressively selling many assets that backed many of these non-performing assets. This is enabling banks to recover some portion of these distressed assets.

WF: Your portfolio currently leans a lot more on asset creators (55%) and is light on asset owners (11%). Is this a function of balance sheet challenges among asset owners? Do you see these weights changing significantly over the next 2-3 years?

Srinivas: Currently public spending on infrastructure is driving the momentum in the infrastructure segment. In our opinion, this is the first phase of a sustainable capex cycle. This is likely to benefit the asset creators. As a result of the increased government spending, asset creators are likely to witness larger order inflows and improved execution numbers. Additionally, falling interest rates will improve the financial leverage in these companies. According to us, Asset creators'category, consistof companies in the following sectors:

1. Construction of Roads, Airports and Railway networks etc.

2. Equipment manufacturers of Power, Defence, Railways, Refineries, construction equipment etc.

The government has made several key policy decisions with regards to transportation, manufacturing, quality of life, affordable housing, power and urban development that have put the spotlight on asset creators.

Asset creators are likely to benefit from the government`s agenda of improving basic amenities and as implementation of flagship schemes like the Pradhan Mantri Awaas Yojana, Make In India & the smart city projects take root. Currently, we believe Asset creators offer better opportunities over asset owners considering valuations and the risk reward scenario.

WF: What is your take on the recent Government announcements involving a Rs.2.1 lakh cr bank recapitalization package?

Srinivas: The government has a clear mandate which we believe, it has used effectively to resolve key issues which plagued the Indian economy. The Bharat Mala highway project and the bank recapitalization are large projects which give their respective sectors a much needed boost on their way to revival. It is also important to note that these initiatives are likely to have a knock on effect on the economy.

The Rs. 2.11 trillion recapitalization package announced by the government is a major initiative towards revitalizing public sector banks (PSBs) grappling with non-performing assets (NPAs) and inadequate capital, and will help them focus on credit growth. The capital infusion would come in two tranches-Rs. 1.35 trillion in the form of recapitalization bonds that will be front-loaded, and Rs. 76,000 crore through budgetary allocations, equity placements and follow-on public offerings.

Front-loading of capital will help PSBs bring forward provisioning for NPAs, and leave them in a better shape to ride the recovery in the credit cycle. Also, with incremental accretion to stressed assets unlikely to materialize going forward, we expect the credit profiles of PSBs to improve materially.

WF: Is a sustainable boom in the infra theme possible without a quick and effective resolution to the balance sheet issues of major asset owners? How do you see this issue getting resolved?

Srinivas: The government has taken a calculated approach to resolve the bottlenecks in the Indian infrastructure sector. The legal challenges in dispute resolution and claims resolutions have been taken care of through a consultative approach in line with the government`s goal of ease of doing business. Resolution and settlement of disputes and exit from business are becoming easier and faster with the Insolvency and Bankruptcy Code, amendment to the Arbitration and Conciliation Act and to the act dealing with securitisation and reconstruction of assets, Commercial Courts Act 2015 and National Company Law Tribunal.

Near term growth is being driven largely by public spending in the roads and power sector. Private spending is expected with a lag effect. Currently we are witnessing green shoots in the private sector on the back of reasonable interest in the HAM model (Hybrid annuity model) for project implementation. Asset creators are likely to show interest in projects if there is reasonable clarity on contracts and manageable risks.

The above government decisions, urgent demand for better infrastructure services along with the business learnings from the previous infrastructure cycle are likely to lead to a sustainable boom in the infrastructure space in the coming years.

WF: Your presentation highlights progress and plans across key infra segments including roads, railways, metros, ports, airports, defence and affordable housing. Among these key segments, where is business momentum and earnings momentum most visible currently and which are the segments where the investment argument is more based on expectations than reality?

Srinivas: Construction and tendering of roads has seen sharp upturn in last three years. Growth in ordering and execution is likely to sustain in FY18 and FY19. Government targets road construction to 40 km/day from present 22 km/day, it was 12km/day in FY14.

The Bharatmala project is an integrated PAN India set of projects aimed to improve the cross connectivity of roadways in India. The plan involves constructing 83,677 km of roads, highways, green-field expressways and bridges in phases.

Under the first phase to be completed by 2022, 34,800 km of highways will be built. This will include 24,800 km of the ambitious Bharat Mala programme, at a cost Rs 5.35-lakh crore, announced two years ago, to build highways through economic corridors centred around manufacturing hubs, inter-corridors and feeder routes, border, coastal and port connectivity roads. 1,837 km of greenfield expressways will also be developed under the programme.

On the railways front, Indian Railways (IR) plans Rs 8.56 lakh crore capex over FY15?19, almost double of FY2010-15. The government process has led to clear visibility of projects and project execution

WF: On a 1 year basis, infra and banking sector stocks have led market performance. Have earnings grown commensurately in the broad infra space or are stock prices perhaps running ahead of expected earnings growth?

Srinivas: Infrastructure companies have seen improved earnings on the back of improving execution, lower finance cost and settlement of historical disputes. This clear trend is likely to continue considering government`s focus on infrastructure and the anticipated new order inflow.

The banking sector has seen several key reforms targeting the NPA issue. We believe that NPA`s have peaked resulting in lower slippages reporting. In addition we believe Provisioning costs expected to fall steadily over next 2-3 years thereby improving earnings.

WF: What do you see as the key risks to the Indian infra story?

Srinivas: Key risks to the infra story are likely to come from the pace of new orders and the pace of execution. Currently the on ground movement in Affordable housing is insignificant. In addition, these risks are likely to be a drag on the economy as well.

DISCLAIMER: The views are expressed by Mr. Srinivas Rao Ravuri, Fund Manager - Equities of HDFC Asset Management Company Limited (HDFC AMC), as on 5thNovember 2017. The views are based on internal data, publicly available information and other sources believed to be reliable. Any calculations made are approximations, meant as guidelines only, which you must confirm before relying on them. The information given is for general purposes only. Past performance may or may not be sustained in future. The replies are given in summary form and do not purport to be complete. The views / information provided do not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this information. The information/ data herein alone are not sufficient and should not be used for the development or implementation of an investment strategy. The statements contained herein are based on our current views and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Stocks/Sectors referred above are illustrative and not recommended by HDFC Mutual Fund / AMC. The Fund may or may not have any present or future positions in these sectors. HDFC Mutual Fund/AMC is not guaranteeing any returns on investments made in the Scheme(s). Neither HDFC AMC and HDFC Mutual Fund nor any person connected with them, accepts any liability arising from the use of this document. The recipient(s) before acting on any information herein should make his/her/their own investigation and seek appropriate professional advice and shall alone be fully responsible / liable for any decision taken on the basis of information contained herein.

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