'If the markets correct further, PSU stocks could continue to decline.'
PSU (public-sector unit) funds, which delivered stellar returns from 2021 to 2024, have underperformed significantly in recent months. These funds have fallen 18.4 per cent on average over the past six months.
Reasons for the slide
The primary reason for this underperformance is over-valuation. Stocks in sectors such as defence, capital goods, railways, and PSU banks had rallied significantly.
"Some of them had become extremely expensive. That's why they have corrected heavily in the market correction since September," says Alekh Yadav, head of investment products, Sanctum Wealth.
Some PSU stocks failed to meet market expectations on the earnings front. "Given the exaggerated valuations, the market had started expecting a linear growth in earnings, which did not happen," says Vivek Banka, founder, Goalteller.
Profit booking, too, contributed to the fall. "Investors had made a lot of profits in these stocks. Many, therefore, booked profits and exited," says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.
Key risks and challenges
The performance of PSUs is closely tied to government policies and spending. "In the first half of 2024, government spending fell due to the elections, affecting many of these companies," says Dhawan.
Many PSU businesses are cyclical, making them sensitive to economic slowdowns and reduced consumption. Government ownership also poses challenges.
"Many of the government's decisions are driven by its priorities, which may not always be best for the earnings of PSUs," says Dhawan.
Capital allocation decisions by the government can also hinder growth. If dividends to the government are prioritised over capital expenditure, these businesses can suffer.
Valuations remain a concern even after the recent decline. "If the markets correct further, PSU stocks could continue to decline," says Banka.
Investing in thematic funds like these requires behavioural discipline. "Ideally, investors should have entered these funds when their past returns looked poor. But very few investors would have done that. Most would have entered much later in the rally when PSU fund returns were looking good," says Yadav.
Opportunities in PSU funds
Despite recent setbacks, investing in PSU funds offers certain advantages. "Government-led capital expenditure may rise, benefiting PSUs," says Dhawan.
In specific sectors like defence manufacturing, PSUs face limited competition from the private sector, ensuring growth opportunities.
PSU banks are cleaning up their balance sheets. "This is in contrast to the rising non-performing assets of non-banking financial companies," says Banka.
Quick recovery is unlikely
The current over-valuation of PSU stocks limits the potential for a quick turnaround. "There is not much scope for an early turnaround in the performance of these stocks. In fact, there may be more downside," says Yadav.
Capex announcements in the Budget may provide temporary relief to these stocks. But divestment plans, by increasing the supply of PSU papers, could hamper price rise.
What should investors do?
Investors who entered early should book profits as they would be sitting on significant profits.
Those who entered the rally late for quick gains should book losses and move to their next bet, as recovery may take time.
Those with a 7 to 10-year horizon may stay put.
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Feature Presentation: Rajesh Alva/Rediff.com
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