MFs bet on engineering stocks

So what makes the engineering sector so lucrative and are the lop-sided investments justified? As per Equitymaster.com, 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.

Equitymaster.com 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.