Mutual Funds: Equity funds focused on PSU stocks soar in value over the past year—should you invest?

Government-owned companies have gained in a big way on bourses propelling the rise of mutual funds focused on PSUs, but should you invest?

They are the best performers in the recent past among widely traded asset classes. But these funds are not from any of the popular investment categories and deploy money only in a narrow band of shares of companies controlled by the government.

Equity mutual funds (MFs) that invest in the shares of PSUs (public sector units) have topped the performance charts having surged by about 92% on an average in the last one year. These funds have generated the highest returns across time frames—one year, three years, five years and on a year-to-date basis.

For starters, there are only a handful of funds to choose from. And their portfolios are heavily stacked in favour of PSUs engaged in the energy and utilities businesses. NTPC, Power Grid, GAIL and ONGC are among the top picks of equity MFs investing in PSUs.

The scrips of these PSUs have been among the best performers on the bourses. While GAIL India has soared by 96.1%in the last one year, NTPC surged by 93.6%, ONGC is up by 91% and Power Grid has gone up by about 79.5%.

The strong performance has resulted in fund houses launching new schemes in the category. Aditya Birla Sun Life MF launched ‘ABSL Nifty PSE ETF’, an exchange traded fund (ETF) that invests in PSU shares in May this year, while Quant MF launched its ‘Quant PSU Direct Fund’ in February. Both these funds have garnered assets to the tune of ₹960 crore since their launch.

Equity MFs investing in PSUs come under the ‘Thematic’ category and are considered quite risky for average investors. The category, however, has three funds—CPSE ETF, SBI PSU Direct Fund and Invesco India PSU Equity Direct Fund with assets totalling nearly ₹47700 crore that have been around for more than a decade. This is long enough to assess performance across different market cycles. These funds had their worst performance between May 2019 and May 2020. They slumped by 31.7% to 47% during the timeframe.

But given their strong performance in recent months, should investors consider committing their money in a category that deploys funds in a small set of government-owned companies? Financial advisors say that investors should weigh the high risks of the category before deploying money in these schemes. Here are a few things you should consider while committing funds in equity MFs that invest in PSU shares.

Several PSUs in cyclical sectors

Several PSUs are in cyclical sectors where fortunes can swing widely affecting their performance, say advisors. For instance, oil and gas is a sector that sees upswings and downswings, which is dependent on several factors including geopolitical risks, currency appreciation/depreciation and global commodity prices. “The impact can be quite significant when the cycle reverses,” says Anil Rego, founder and CEO, Right Horizons, a Bengaluru-based wealth management and PMS (Portfolio Management Services) firm.

Infrastructure spending boost

PSUs came out of a long downturn when their valuations dropped drastically. Since many of them were in infrastructure-related sectors, the government’s increased focus on them has had a positive impact on companies. PSUs saw an uptick in their fortunes in tune with the government’s spending on the sector to improve the overall economy, say experts. The allocation for infrastructure spending, as a percentage of GDP (gross domestic product), has surged from 1.13% in 2019-20 to a projected 3.3% in 2023-24. If the government continues to spend big on infrastructure, PSUs would gain.

Price controls may be a spoiler

The very nature of these companies means that they do not run merely on market dynamics of supply and demand. Pricing is one of the biggest risks for PSU companies. In the past, the government had imposed price curbs to shield consumers from adverse consequences of higher rates, especially in the case of oil marketing companies (OMCs).

“PSUs are subject to government control on pricing. Their profitability depends on what the government allows them to charge, which can be quite risky for investors,” says Suresh Sadagopan, managing director and founder, Ladder7 Wealth Managers, a Mumbai-based wealth management firm.

Restrict your exposure

Advisors say that investors should restrict their exposure to such funds as the risks are quite high. Booking profits at the right time is the key in ensuring good returns, they say. “Lay investors cannot be continuously invested in a sectoral fund. Investors have to be cautious as it is risky. They should restrict their exposure to a maximum 5% of their portfolio,” Rego says.

Allirajan M is a journalist with over two decades of experience. He has worked with several leading media organisations in the country and has been writing on mutual funds for nearly 16 years.