SANJAY KUMAR SINGH Place bets on defensives like FMCG in volatile market

With pharma sector faltering and IT too facing uncertainty, FMCG sector funds look like a safe-haven category

If you look at the trailing returns of fast-moving consumer goods (FMCG) sector funds, they are remarkably attractive ( see table). Turn to the year-wise performance and they are equally eye-catching: These funds have given positive returns every year over the past decade (returns were negative only in 2008).

With the pharma sector faltering in recent times, and information technology (IT) facing its own growth-related troubles, FMCG remains the last defensive sector that investors can seek a refuge in as the markets turn turbulent.

Several factors have contributed to the stellar performance of FMCG funds. “Consistent earnings growth relative to the broader market has been the biggest driver for the FMCG sector so far. Rural growth and penetration, distribution expansion, raw material tailwind, cost efficiency initiatives undertaken by most companies, and more recently, GST-led benefits have aided the sector’s earnings,” says Atul Patel, fund manager, ICICI Prudential FMCG Fund. He adds the TINA (there is no alternative) factor has also helped the sector, since the much-awaited earnings recovery in cyclical sectors has proved elusive so far. Due to the sector’s consistent outperformance in terms of earnings growth, the market has rewarded it with generous valuations. “Over the past decade, 25 per cent of returns have come from the sector's re-rating and the balance from earnings growth,” says Saurabh Pant, fund manager, SBI Consumption Opportunities Fund.

The key to the stellar performance of this sector is its resilience even during economic and market downturns. FMCG companies are generally stable, their balance sheets are debt-free, and they also tend to have higher free cash flow and return on equity (RoE) than highly leveraged cyclical companies. Their lower earnings volatility makes the sector a good defensive bet in bear markets.

In the future, the sector may continue to do well, but fund managers expect the outperformance to moderate. In the first half of this decade, sector profits were driven by healthy revenue growth derived from growth in rural areas. In the second half, though revenue growth weakened considerably, margins improved owing to subdued cost inflation, benign competitive intensity, and GST benefits. “We are starting from a base of very healthy margins. There are downside risk to margins because as growth picks up, competitive intensity is likely to increase. Commodity prices have begun to inch up, and it may be tougher to pass on cost inflation to consumers,” says Pant. He, however, adds that the large gap in performance among consumer stocks every year suggests there is still opportunity to create alpha.

The only negative aspect about FMCG funds is that since they belong to a low-beta sector, they tend to underperform in strong bull markets. “But when the markets are volatile and unpredictable, as they are currently, FMCG, a steadygrowth sector, is a good place to invest in,” says Nikhil Banerjee, cofounder, MintWalk. He adds that investors should limit their exposure to individual sectors to 5 per cent of their equity portfolio. The longer the time exposure that investors have, the better, but five years is the minimum for which they should invest in these funds.