WF: In what way is your Capex Opportunities theme different from the normal infrastructure theme? Why is this a better theme than the traditional infrastructure theme?

Sri Vidhya: We think ours is a more apt fund for the infrastructure space because typically infrastructure funds that are there in the market are diluted by a variety of sectors which may not be directly related to the infrastructure space.

The way we look at the opportunity in the infrastructure space is essentially companies which are providing services or equipment or construction related work to the client companies which are executing projects. These projects could be infrastructure related as well as projects under corporate capex plans.

The reason for this focus is that capex programs on the infrastructure side or on the corporate sector side tend to have fairly long time periods of roughly two to three years or beyond. During the period of implementation of these projects there is a gestation involved and only when the projects are completed and the assets start earning returns, do the client companies benefit. Meanwhile, companies executing these projects for the client companies start getting revenues and profits from the time the project work commences itself. Also, these service providers are not asset intensive and therefore their own capex needs are relatively less. So return on assets and return on capital are higher for these companies.

And in terms of margins also, there are certain bands in which these companies operate. For example if it is construction company, it will typically have around 8% to 10% kind of margins. If it is an equipment company, margins are higher maybe upwards of 15%. So given the kind of opportunity which we have in India, given the fact that we are under invested in terms of creating capacities or infrastructure, there seems to be an opportunity going forward for several years.

Bearing in mind that kind of an opportunity, the number of companies to execute these projects is fairly limited. To that extent there is a demand-supply mismatch prevailing for these companies.

And finally, if you are executing a project for somebody else; you don't need too much of capital - so equity dilution risks are also fairly low.

WF: If the demand is huge and growing and domestic supply is limited, why can't overseas companies come in and compete with some of the domestic service providers? Are there any entry barriers here ?

Sri Vidhya: Yes, in terms of contracting companies, you need have the local presence - you need to manage the workers on the ground, you need to have the knowledge of local conditions and so on to manage the system.

The second aspect is after sales service. The foreign company may not be able to have that kind of network that is required. If an equipment fails, if it is a critical equipment it has to be replaced and in a matter of few days or hours. You need to have the after sales network to take care of it.

Thirdly, order sizes at least historically were not large enough to attract global giants. Probably now, with order sizes going up, more foreign equipment companies can look at setting up operations in India - some are already there now.

WF: One big worry in this sector is execution risk. Do the companies in this space have the wherewithal to actually execute the rapidly growing order books and do justice to the opportunity? What's your assessment after meeting with all of these companies?

Sri Vidhya: Lets look at the order book and the execution. If you look at a company like IVRCL, which is fairly a small company, in March 2005 their turnover was around 1000 crore. Currently in March 2009, it is around 5000 crores. So they have scaled up 5 times in 4 years.

See, there is lot of sub-contracting which happens especially in the construction side, on the fabrication side. There are also a lot of ancillary units which support the main company. IVRCL has several ancillary units around it. So there is an amount of outsourcing which happens in order to speed up things. I think these companies will grow and scale up in order to tap into these opportunities.

The risks or limitations are clearly on getting the approvals in time, on getting their financial closures. On the direct on-the-ground execution, I don't think there has been any major concern. It is more the approval process and getting things in place before you start work.

Whatever internally can be done to scale up the institution, most companies are doing that. In fact it makes lot of sense for them to complete projects ahead of time; in some cases there are incentives to do so.

WF: Many investors invested in infrastructure sector funds in 2007 - at peak valuations. Their memories have not been sweet. Now, there is a lot of buzz again on this sector. How are valuations now? Are they already stretched or do you see good prospects for returns from these levels?

Sri Vidhya: If you look at look at the NAV of our Capex Opportunities Fund, we are at the October 2007 levels. Investors who bought this fund prior to October 2007, are now in the money. October 2007 to January 2008, the markets ran up very sharply : we are still behind those NAV levels.

On a 3 year basis, we are still fine. In fact we are in line with the NIFTY index now - you were no worse off for investing in an infrastructure fund as compared to the Nifty.

On the issue of current valuations, there are two aspects. Larger companies are at moderately high valuations. There is some justification because there are not too many large companies and their scale is far higher than any other small or medium scale smaller companies. So to that extent, we have some scarcity premium as well as the size aspect - which can justify some rich valuations.

On the other side, there are several smaller companies which have fairly attractive valuations - in the 10 times to 12 times range. You have a mix of both - so it is not possible to generalize.

Also, market is also some 20% below its all time - so to that extent, it is not too much of a concern that you are buying at a top.

Nevertheless, given the fact that this is a thematic opportunity, one has to either one have a discipline of booking profits regularly whenever there is a sharp rise and investing whenever there is a significant fall, or one has to keep adding to your holdings periodically and see this as a very attractive opportunity for a long term basis.

WF: I suppose your company's dividend policy also comes very handy for an investor in such cases - because, if there is a sharp rise, you anyway have an active dividend policy to ensure that there are regular payouts when profits are substantial. To that extent, you are doing that job as well for the investor.

Sri Vidhya: Yes, that is correct.

WF: Within the entire infrastructure space, are there any pockets where you are cautious at the moment - which you would like to avoid in your fund?

Sri Vidhya: I don't think there is anything that we are very negative on, right now.

WF: And finally, since the big buzz in the market is infrastructure, if will be invaluable if experienced fund managers like you can highlight the key risks you see in this whole theme. What can upset this party? What should advisors and investors watch out for?

Sri Vidhya: Well, clearly when everybody is talking about infrastructure - or for that matter - any particular theme - one needs to be cautious and do enough homework.

One has to bear in mind the valuations and the growth expectations it represents. One has to invest in companies that remain attractively valued - on the basis of realistic growth expectations.

Next, this is a sector that depends a lot on Government policy and a lot of Government support. Any change in Government's focus on this sector or any financing constraints or any constraints in granting approvals and pushing through key projects can impact this sector.

Balance sheet strengths of companies that take up these projects need to be reviewed very carefully. Their capability of executing these projects needs to be clearly vetted.

And finally, certain key macro factors like interest rates and commodity price trends will impact margins of companies in this sector - and need to be monitored closely.