Parting Note | Best is yet to come in PSU stocks, says Prashant Jain

In recent years, Prashant Jain, prolific fund manager and former chief investment officer of HDFC Mutual Fund, was criticised for his outsized exposure to public sector undertakings (PSUs).

Initially, criticism was understandable. The portfolio he was managing at the fund house was underperforming others largely due to PSUs as the BSE PSU index fell at a compound yearly rate of 22.3 percent from January 2018 to October 2020.

Everyone on the Street believed PSU stocks were a gone case. However, Jain eventually had the last laugh as PSU stocks are hot cakes now. The BSE PSU index has grown to a compound yearly rate of 44.5 percent since October 2020. And, if we listen to Jain, the best is yet to come.

“It is evident that PSUs have not underperformed across all time periods,” he said in a parting note on August 30. Jain resigned from his position at HDFC Mutual Fund last month, surprising Dalal Street. He was one of the most successful fund managers in India managing the largest asset base among peers.

“The underperformance from January 2018 to October 2020 was so sharp that it led to underperformance even over longer time periods, creating an impression that PSUs are no good.

“As is often the case in investing, herd behaviour and majority opinion is more often wrong than right. The sharp outperformance of PSUs in recent years (I believe the best is yet to come) has reiterated this once again.”

Some of the PSU stocks, especially from the defence space – Bharat Electronics, Bharat Dynamics and Hindustan Aeronautics – have gained 80-120 percent in the last one year. The rally has also spilled over into PSU banks and energy names. This has also led to fund managers buying them even more.

“It is heartening to see PSUs increasingly finding their way to more and more mutual fund portfolios and I am confident they will over time find their way into more FII (foreign institutional investor) portfolios and direct portfolios as well,” said Jain.

According to him, the core reason for underperformance of PSU stocks between 2018 and 2020 was the economy not doing well. Lower flows into exchange-traded funds (ETFs) also impacted their performance. However, now that both have recovered, the PSU stocks are Street favourites again.

This question has made its way into discussions with fund managers more often than one realises. The market has come full circle on this issue – from avoiding stocks from tobacco, defence and energy sectors before the pandemic to their outperformance in the last couple of years.

Jain believes with the rally in these sectors, “rationality” has eventually prevailed.

“Reasonably priced energy and adequate defence preparedness are basic to a nation/society’s well-being. Lack of investments in these areas can lead to difficult outcomes as the world is realising and experiencing,” he said in his note.

“There is in my opinion a need to have a realistic assessment of technological limitations, real costs, realistic timelines, and risks,” he added.

Nonetheless, Jain believes investing based on ESG (environmental, social, and corporate governance) has noble objectives but the way it is being exercised is flawed. Many pension funds including the largest ones based in Norway and some institutional investors have said they will not invest in companies with low ESG score.

“The answer to solving these issues is not in mechanical scores (at times deficient) and in exclusion investing, but rather in encouraging/incentivising companies to adopt more ESG-friendly technologies, processes and mechanisms via market forces and other means.”