Sensex makes a defensive play

Share of IT, pharma, and FMCG companies in Sensex to rise to 38% next month; manufacturing losing sheen

The Dalal Street may be waiting for a revival in capital expenditure and investment, but investors are putting their bets on defensive sectors - FMCG (fast-moving consumer goods), information technology (IT), and pharmaceuticals, which are least sensitive to a turn in growth cycle. Investors are withdrawing from growth-sensitive industrial and manufacturing companies.

Based on current market prices, the share of defensives in the benchmark S&P BSE Sensex is at an all-time high of 37 per cent, and will rise to nearly 38 per cent by the end of the next month as Asian Paints and Adani Ports replace Vedanta and Hindalco Industries on the index. Defensives accounted for 34.2 per cent of the Sensex companies combined free-float (non-promoter) market capitalisation at the end of March this year (see chart).

In contrast, cyclical and economy-sensitive sectors such as metals, energy, capital goods, infrastructure, and power, continue to lose favour with investors. After the latest index rejig by the BSE, shares of industrial companies on the Sensex will fall to an all-time low of 20.3 per cent, down from 23.5 per cent at the end of March. At its peak in March 2010, industrials had 43.5 per cent weightage in the index.

The industrial sector includes Reliance Industries, which was at one time the country's most-valuable company and most-influential on Dalal Street in terms of index weightage. At present, Tata Consultancy Services (TCS) tops the market capitalisation chart, while FMCG firm ITC is the most-influential stock.

A decline in the importance of industrials is in line with a fall in India's manufacturing sector in the past few years. Manufacturing and industrial companies together accounted for only 54.2 per cent of India Inc's combined net profit in financial year 2015 - down from 69 per cent five years ago - while they account for 75 per cent of total companies. The sector profit share would fall further to 41.5 per cent if FMCG and pharma companies were to be excluded from the sample.

The analysis is based on a common sample of 901 companies that are either part of BSE 500, BSE mid-cap, or BSE small-cap index.

Experts blame it on the economic slowdown and its disproportionate impact on industrial companies. "The profitability and market value of industrial and manufacturing companies is down to multi-year lows thanks to a tough macroeconomic environment. In comparison, most defensive companies continue to grow and remain profitable even if their pace of growth has declined. This has led to a huge valuation gap between these two groups," says a fund manager, who spoke on the condition of anonymity.

As benchmark indices are designed to reflect the largest stocks in terms of market capitalisation and most liquid stocks at any time, industrials have lost out to defensive companies. "For some time now, investors' money has been moving to defensives and away from struggling companies in manufacturing and industrials sector. The changes in index composition reflects the trend, though with a lag," says Alex Mathews, head, research, Geojit BNP Paribas Financial Services.

On the brighter side, the rising share of defensives makes the index a little more resilient to macroeconomic volatility. Given the nature of their business and debt-free balance sheets, FMCG, IT, and pharma companies are greatly insulated to short-term changes in the external economic environment, unlike industrial companies.

On the downside, the benchmark index now becomes relatively less sensitive to developments in the broader economy, especially in the industrial and infrastructure sectors.