Last calendar year, infrastructure funds shot to prominence by topping the performance rankings. Among the five best performing diversified equity funds, three were infrastructure funds. So it comes as a bit of a surprise to know that infrastructure was not even recognised as a separate theme a few years ago.

It was the government's planned infrastructure expenditure of $320 billion during the eleventh 5-year plan (2007-2012) that did the trick. Even if half of it materialises, infrastructure funds will be able to generate great returns.

UTI Infrastructure was the first to grab the opportunity in April 2004. Talk about the early bird getting the worm, it was the best performing equity fund in 2006 with a 61.5 per cent return. Tata Infrastructure and ICICI Prudential Infrastructure delivered 61.5 per cent and 60.3 per cent respectively.

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This was no mean feat considering that in 2005, no infrastructure fund featured in the top 10 return generators. Currently, there are 12 funds dedicated to this sector. The latest entry into the fold is DBS Cholamandalam with a three-year, close-ended fund.

Defining Theme

Each fund house will have its own definition of what can be clubbed under the infrastructure theme. At its very fundamental level, it will only include capital goods and engineering companies. So ABB, Bharat Heavy Electronics Ltd, Greaves Cotton [Get Quote], Jyoti Structures [Get Quote], Larsen & Tubro, Punj Lloyd [Get Quote], Suzlon [Get Quote], Lakshmi Machine Works [Get Quote] and Gammon India [Get Quote] will be the prototypes.

But the theme can be extended to encompass cement stocks, construction stocks, refining and even telecom stocks. Can Infrastructure has held Bharti Airtel [Get Quote] since October last year and is now 3 per cent of its AUM.

Similarly, Tata Infrastructure's top holding is Reliance Communication (5.44 per cent) and Bharti Airtel figures in its top five holdings.

Real estate stocks too have found their way to these portfolios. For exapmle DLF figures in the portfolio of Can Infrastructre. JM Hi Fi bought Peninsula Land [Get Quote] in December 2006 and Ansal Properties and Infrastructure in May 2007. The latter added Housing Development and Infrastructure in July.

What does appear startling is the presence of banking and pharma companies in an infrastructure fund. The logic? Financial institutions like HDFC [Get Quote] and IDFC [Get Quote] and banks also lend to the infrastructure sector. DSPML T.I.G.E.R invested heavily in HDFC and the stock now figures in the top three holdings of the fund house (as per June portfolios).

Number Game

Here you will find funds on both ends of the spectrum. Some have as many as 70 stocks in their portfolio while others are content with 20-odd.

Tata Infrastructure has a huge collection of 66 stocks which is down from 70 (February 2007). But JM Hi-Fi has turned on the aggression. It has reduced the number of stocks to almost half from 35 to 40 last year with a third of its allocation to mid- and small-caps.

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Perhaps this aggression was the reason the fund fell over 18 per cent in the first quarter of 2007, much more than its peers. Compare that with DSPML T.I.G.E.R, which fell only 3.76 per cent during that time. A diversified portfolio of 60 stocks with half of them in large-caps is what limited the downside. Some funds like ICICI [Get Quote] Prudential Infrastructure have been playing in derivatives in a big way. As per the July 2007 portfolio, the fund had around 12 per cent of its assets in Nifty Futures, a steady rise from February this year when the figure was 7.87 per cent.

Taming Expectations

After the stock market's steep fall in February-March, the fastest to recover were capital goods stocks. Since they constitute the bulk of such portfolios, the returns of infrastructure funds got a boost. The BSE Capital Goods index rose 14.6 per cent in April and rose further by 10 per cent in the month of May as well as June.

For the five-month period ended August 6, the index rose by more than 54 per cent. On the other hand, the Sensex generated returns of only 20 per cent during the identical period. Among other sectoral indices, BSE Metal delivered 38 per cent and BSE Oil and Gas and BSE Bankex, 28 per cent each. With metal and oil stocks dominating such portfolios, these funds benefited. For instance, oil and gas major Reliance Industries [Get Quote] is the top holding of UTI Infrastructure and DSPML T.I.G.E.R.

Nevertheless, performance might not be as good as the previous year because several of the construction, real estate and basic engineering stocks now command very high valuations. Though infrastructure will remain a powerful theme, investors should tone down expectations.