Public Sector Undertaking (PSU) mutual funds have outperformed other thematic categories, delivering average annualised returns of 27.51% over three years and 25.01% over five years. This rally, fueled by infrastructure spending and bank turnarounds, highlights the impact of government-linked themes. However, investors should evaluate the risks of policy dependence and high valuations before considering these as long-term holdings.
What Happened
Public Sector Undertaking (PSU) mutual funds have established themselves as the top performers among thematic funds in recent years. Data shows these funds delivered an average annualised return (CAGR) of 27.51% over the past three years and 25.01% over the past five years. This performance has outpaced other significant thematic categories, including energy, pharma, and IT funds.
The Drivers of Growth
The strong performance is largely attributed to specific policy and economic shifts. Government capital expenditure in areas like railways, roads, and infrastructure has acted as a tailwind for many state-owned enterprises. Additionally, PSU banks, which previously struggled with asset quality, have undergone a significant turnaround in profitability, which positively impacted their stock prices. Furthermore, the ‘Atmanirbhar Bharat’ initiative has accelerated indigenisation in the defense sector, resulting in large order books for defense-related PSUs.
The Thematic Factor
A key insight for investors is that the performance was driven by the broad theme rather than individual stock-picking by fund managers. The difference between the best and worst-performing PSU funds over the last five years was a narrow 1.22 percentage points. This suggests that the market rally in the PSU segment was a rising tide that lifted all ships, rather than a result of specific fund manager skill.
Long-Term Market Leadership
While PSU funds are currently leading, history shows that thematic leadership is often cyclical. For example, over a ten-year horizon, energy funds have historically held the lead with a 17.14% CAGR, followed by infrastructure at 16.55% and PSU funds at 16.43%. This data serves as a reminder to investors that sector outperformance rotates over long periods, and the current rally in PSUs may not be permanent.
Risks and Considerations
While the returns are attractive, PSU funds carry unique risks. The most prominent is concentration risk, as these portfolios are restricted to government-owned companies. This makes them highly sensitive to government policy changes, public spending cycles, and geopolitical developments. Additionally, many of these stocks are cyclical, meaning their performance is tied to the economy's ups and downs. After a prolonged rally, some investors may find valuations stretched, and the category often exhibits higher volatility compared to diversified equity funds.
What Investors Should Track
Financial advisors often suggest treating thematic funds like PSU funds as a 'satellite' allocation—a small part of a larger, diversified portfolio—rather than a core investment. Investors looking at this space should assess their own risk tolerance and time horizon, which is typically suggested at 5 to 7 years. New investors or those seeking steady, low-risk growth may find these funds too volatile compared to broad market indices.