Investment Blog

A client of mine asked me if we could invest in infrastructure funds, given the strong focus of the Government on the infrastructure sector.

The sector is undoubtedly expected to do good, but is it a good investment right now? Most probably not! Why is that so? Because it has been a popular narrative for quite some time.

But, what’s the problem with investing in popular narratives?

The problem is the level of valuations.

Popular investment sectors or themes gain momentum as more investors join, driving prices much higher than the worth of the underlying assets. This positive feedback loop creates inflated prices that may not yield substantial long-term returns, even if the firms in the sector do well on the business front.

Recall a few examples from the past:

– IT sector was super popular in 1998-2000 but ended up being the worst performer in terms of returns
– The infrastructure sector was popular in 2005-2007 but led to heavy losses over the next few years
– ESG theme became very popular globally during 2019-2021 but resulted in negative returns over the next few years

Currently, in the infrastructure sector, there are not many companies with strong management and many belong to the mid/small cap space which is very popular again and thus over-valued. L&T, a bellwether company in infra space is trading at a high PE of 40x with only 3% profit growth in the last 5 years.

Similarly, sectors or themes with strong long-term fundamentals but currently out of favor often present excellent investment opportunities. This happens because the prices discount the negatives more than warranted and become attractive for investment.

Human behavior drives prices to extremes in either direction. A good investor should take advantage of the collective human folly to make above-average returns.

Originally posted on LinkedIn: www.linkedin.com/sumitduseja