The Benefits and Risks of Investing in Manufacturing Funds
Manufacturing mutual funds are the new entrants to the large family of equity funds, focusing largely on investing in companies in the manufacturing sector. With the government at the helm of schemes like Make in India and the PLI scheme, the manufacturing sector can drive India toward a $5 trillion economy target. But even with great scope for growth, investing in manufacturing funds introduces certain risks. The following article will discuss in detail the pros and cons of investing in manufacturing funds and allow the investors to make a more fact-based decision based on the investment.
Benefits of Manufacturing Fund Investment:
Some new schemes focus on the manufacturing sector, such as the HDFC Manufacturing Fund, with its benchmark index, the NIFTY India Manufacturing Index. Here are some pros of investing in a manufacturing-oriented sectoral mutual fund:
- Exposure to a Rapid Expanding Sector -
Manufacturing accounts for almost 17% of India's GDP, which is relatively high for a country still in the developing stage. Manufacturing is at the core of India's growth strategy, which aims to increase this share to $1 trillion by 2025-26.
Therefore, manufacturing funds make sense to align the investors' portfolios with this growth narrative. As India aspires to transform into a manufacturing hub, manufacturing companies, driven by the twin engines of rising domestic demand and exports, are most likely to witness robust growth in earnings and, hence, furnish better returns to investors.
- Focus of the Government in this segment:
Policies and Incentives by Government The Atmanirbhar Bharat (self-reliant India) and such policies will raise India's manufacturing potential by enhancing production, helping cut import dependence, and, at the same time, attracting significant inflows of foreign direct investment. Mutual funds that invest in manufacturing companies are consequently enjoying some of the fruits of these government policies, which advocate for competitiveness, innovation, and enhanced production.
- Diversified portfolio:
Diversification of manufacturing exposure between automobiles, chemicals, textiles, pharmaceuticals, electronics, and others gives this sector experience in various other industries. This sector diversification reduces the company-specific risks because the fund is normally invested in different subsectors driven by other growth drivers, demand cycles, and competitive advantages.
So, the fund's performance will not be affected by any specific industry in the manufacturing sector.
- Potential for Long-Term Outperformance
Historically, manufacturing-themed mutual funds have outperformed broader market indices across time horizons, such as the Nifty 500 and Nifty 500 Multicap. The manufacturing segment, ready for benefits with the upward graph of urbanisation, improved consumer demand, and export, also provides a rich investment basis. With enhanced efficiency and innovation under their belt, companies in the manufacturing space are expected to see growth in earnings, margin expansion, and re-rating, a matter of great potential for resultant outperformance from funds in the manufacturing theme.
- Opportunities in Emerging and Niche Segments:
The manufacturing sector provides the emerging industry of electric vehicles, renewable energy, and advanced manufacturing technologies, all of which facilitate investors' reaching niche segments that are expected to have high growth. This presents an opportunity for manufacturing funds to invest in innovation-driven areas that may surpass traditional manufacturing sectors by acquiring market share and attaining scale.
Risks of Investing in Manufacturing Funds
- Market and sector-specific risks:
Manufacturing funds give you exposure to a high-growth sector, but they are also subject to market and sector-specific risks. The manufacturing sector is cyclical, so its performance depends on the economy. The performance of manufacturing companies could be hurt sharply by fluctuations in raw material prices, currency movements, inflation, or changes in consumer demand. Trade policies, labour disagreements, and regulatory changes can also increase uncertainty and risk within the sector.
- Volatility:
As per the SEBI categorisation, the High-Volatility Manufacturing funds belong to thematic funds, which, by default, means the investment opportunity is lesser, unlike the diversified equity funds. Hence, these factors will try to plot high-volatility risk prospects. For example, at the time of an economic slowdown or a reduced pick-up in the manufacturing sector, these funds may not perform as well as other broad market indices. Investors should be prepared for periods of high volatility and potential short-term losses.
- Concentration Risk:
Manufacturing funds often have concentrated exposure to a few companies or subsectors within the manufacturing industry. While this can lead to enhanced returns in the case of well-performing companies, it also magnifies the risk of underperformance should one or more companies start to face challenges. For example, a big investment in the automobile sector could suffer when consumer demand for vehicles goes down due to economic factors or disruptions in vehicle manufacturing supply chains.
- Not much historical data:
Recent performance data has been good, but there is no certainty that the trend will continue. Investors should, therefore, be careful to consider these funds only as part of a diversified portfolio rather than relying on them for returns. Limited Historical Performance Information Manufacturing funds, such as the HDFC Manufacturing Fund, are relatively new in India, and quite a few have a short track record. This lack of history has made it tough to predict long-term performance because, though recent returns have been relatively good, there is no certainty that the trend will continue. Investors must be cautious and consider these funds part of diversified portfolios rather than depending on them for returns.
- Higher Expense Ratios:
Thematic funds, including manufacturing funds, typically have a higher expense ratio than diversified equity funds. Much research identifies and tracks the best-performing companies within the manufacturing sector. Higher expenses will eat into your overall returns, making it highly critical for investors to weigh the expense regarding management fees versus the potential gain.
Should You Invest in Manufacturing Funds?
Manufacturing mutual funds are an attractive opportunity for investors to benefit from India's manufacturing boom, driven by government policies and rising demand for manufactured goods. These funds present exposure to a broad spectrum of industries and potential long-term capital appreciation.
However, manufacturing funds are not risk-free. Their performance is closely related to practices in the sector's economic conditions so they can be volatile. In addition, the cyclical nature and the risks related to concentration require investors in such funds to exercise patience, long-term horizons, and an understanding of the broad macroeconomic environment.
Manufacturing funds can be valuable to a diversified portfolio for knowledgeable investors comfortable with intrinsic risks. Investing in more stable and diversified options might be best for a low-risk tolerance and short-term investment goals.
