Mutual Funds hitch a ride on transport and logistics boom in India

What works

Transportation and logistics as a theme is directly linked to economic activity in a country. The greater the economic activity, the more the demand for such businesses. The schemes intends to benefit from this.

There are multiple drivers of growth in place. Rising per capita income leads to more aspirations and demand for better transportation services. A strong recovery in the economic cycle is pushing growth for movement of goods within the country as well as for exports.

Government policies such as production-linked incentives are aimed at boosting the manufacturing sector in India and will ensure that segments such as automakers benefit directly. Other segments including logistics services benefit indirectly with the rise in the movement of goods and people.

Logistics can be a key segment to watch. The formalisation of the economy, implementation of the Goods and Service Tax, and increase in e-commerce transactions are secular growth-focused tailwinds for companies in this sector.

The theme incorporates as many as 22 sub-sectors including auto, auto ancillaries, shipping, ports, railways, roads and airlines. The fund managers can also invest in overseas stocks that fit the theme.

“The transportation and logistics sector contains a wide spectrum of investment opportunities and can be a good investment given the fact that we are coming off a cyclical bottom with respect to industry volume and profitability,” said Pinto of IDFC Mutual Fund. “This is the best time for medium- to long-term investors to enter into this theme.”

Over the five years ended October 6, 2022, the Nifty Auto Index and the Nifty Transportation & Logistics Index generated returns of 3.04 percent and 6.18 percent, respectively. Over the same period, the Nifty 500 Index gave 11.37 percent returns.

However, Bihani, fund manager of ICICI Prudential Mutual Fund, said that for such thematic funds, past performance doesn’t reflect future potential.

“Over the last 10 years, we have seen muted volume growth in the auto segment as various global or local disruptions led to either lower income, which hit demand, or lower supply due to component supply disruptions. These issues are now behind us,” Bihani said. “Even sector-specific issues such as emission norm changes and insurance cost hikes are behind us. Also, commodity prices are coming down. As the economy recovers, the sector should see higher pent-up and replacement demand.”

What doesn’t work

An economic slowdown can impact these sectors and therefore, the schemes that track them. A possible global slowdown and recession, especially in the US, is a danger to these funds.

However, Bihani does not consider it to be a big threat as of now.

“Global recession may dampen some export demand in the near term. But as of now, if we keep aside certain specific auto OEMs (original equipment manufacturers) and ancillary players that have higher export share, the entire overall domestic recovery for this theme will still continue despite global headwinds.”

He expects global volatility to stabilise in the next six to 12 months.

“Together with Indian companies gaining market share in global trade on account of the China-plus-one policy and expanded capacities backed by production linked incentives, exports too will go up materially in the medium term,” he said.

Rising interest rates can put some pressure on demand for vehicles. But Pinto does not consider it to be a significant headwind.

“We have seen almost flat or low growth in vehicle purchase numbers in the last few years. The expectations of ‘need-based demand’ for vehicles should ensure that the sector will see high growth numbers in the future despite rising interest rates,” he said.

Commodity prices and crude oil prices are two key variables that investors need to monitor. Though commodity prices have come down, crude oil prices are still not in the comfort zone, threatening the profitability of transporters.

What should you do?

These being sector-specific funds, investors need to get the entry right. Though experts indicate that now is a good time for these funds, make sure you are suited for a thematic fund and the volatility that comes with it.

Sector or thematic funds should never be your first mutual fund investment. If you have already built a core portfolio comprising a diversified equity fund and are looking to allocate more, then you can take a small exposure to any of these two new schemes.

“Generally, a theme or sector draws attention after it has already exhibited growth and become popular among investors,” said Deepak Chhabria, founder of Axiom Financial Service. “This theme has shown initial signs of recovery. It can be an interesting candidate for a satellite portfolio.”

Take a look at some alternatives, too. UTI Transportation and Logistics Fund is an existing scheme that has given 6.76 percent returns over the past five-year period.

There are also passively managed auto sector index ETFs offered by Nippon India MF and ICICI Prudential MF for those who are keen to avoid fund manager risk.

Passive funds help you to invest in sub-sectors of the theme.

“An actively managed fund is better placed to take into account the expected ongoing disruptions and identify future winners in the sector. Index funds as of now have high allocations to winners of yesteryear – some of them are not investing as much in new technology and they may not remain sector leaders going forward. Index funds may take a bit more time to align with this,” said Bihani.

The new fund offering closing for IDFCTL is October 18 and for ICICITL is October 20.