Weekly Musings – NFO Pick (SBI Innovations Opportunities Fund)

5 Aug 2024 , 01:39 PM

HOW DO WE DEFINE INNOVATIONS IN FUND SELECTION?

Innovation is like happiness. Hard to define, but you can make out when you see it. That may be too poetic, but innovation here refers to disruption. Any product, idea, process, or even protocol that promises to disrupt the way business is done can be defined as innovative. As we look around, there are scores of such innovative ideas that have transformed the lives of individuals and businesses in the last 20 years. Here is a sampler.

• The automobile sector has been substantially disrupted the growing importance of hybrid cars, self-driven cars, and electric vehicles (EVs). Not surprisingly, Tesla is the most valuable auto company in the world.
• In financial services, the dividing line between finance and technology is thinning. The big changes in financial services are coming from the united payment interface (UPI), Blockchain, Payment aggregation etc.
• What about energy. It is not about fossil fuels any longer. The big trends of the future are green hydrogen, green ammonia, lithium ion batteries, efficient batteries, high intensity batteries, grid integration, solar storage etc.
• Even something as simple as groceries has been disrupted like never before. Quick Commerce has been a big disrupted and has changed the way people demand from retail. Omnichannel integration and AR are the other big innovation challenges.
• In the media sector, you only look at how OTT platforms like Jio, Netflix and Amazon Prime have disrupted the media space. Marketing is fattening its digital content and digital delivery while today music and videos stream effortlessly under 5G.
• Even technology sector is changing. Businesses are increasingly relying on cloud storage and cloud computing. Generative AI and IOT promise to revamp manufacturing and data centres are driving most of the real estate demand in India.
• Finally, if you look at the industrial scene, even that is getting disrupted. Operations are being automated through drones and robotics. 3D printing and nanotechnology are still at an infant stage, but they can be powerful disrupters.

The moral of the story is that disruption and innovation can be a powerful investment theme in the years to come.

WHY INNOVATION AND DISRUPTION WILL BE BIG IN INDIA?

India has moved up sharply in the Global Innovations index and that, in itself, is going to be a major boost. There are several factors why innovative disruption will be big in India.

• India has a very robust start-up ecosystem to support innovative companies. There several exemplar innovative companies across fintech, ecommerce, media, edtech, healthtech, logistics, and quick commerce. We have seen listed disrupters like Zomato, Nykaa, Delhivery, Ola Electric, FirstCry etc
• Secondly, India has a very strong talent pool to support innovation with 2.5 Million STEM graduates churned out each year. AI penetration skills are much higher in India. More than half the graduates come from tier-2 and tier-3 cities, making seamless expansion possible for economies of scale based start-ups.
• Very importantly, India has sold digital infrastructure. With over 80 Crore smartphones, over 1 Crore active 5G devices, more than 7,000 5G-enabled cities in India, lowest cost of internet access among the large economies, over 138 data centres and more than 118 Billion UPI transactions in the year 2023 are all testimony to digital readiness.
• The consumer market is expanding and even the mix favours innovation. Between FY20 and FY31, the number of wealthy households are likely to triple, while the middle class is likely to grow by over 70% to 16.5 Crore. This growth will come at the cost of the aspirers and the destitutes, showing a quantum upward shift in purchasing power.
• Finally, there is the smart combination of government support and a strong funding ecosystem. India has set up a pool of over $30 Billion for the product linked incentive (PLI) scheme. Between 2014 and 2024, the start-up funding size has grown by more than 30 times in the last 10 year and has still just about scratched the tip of the iceberg.

Let us now turn to what are the kind of specific companies that the SBI Innovations Opportunities Fund will invest in.

INVESTMENT APPROACH OF SBI INNOVATIONS OPPORTUNITIES FUND

Broadly, there are 4 categories of investments that the fund would be looking to create its investment portfolio.

• Product innovators or the companies that leverage on research & development (R&D) to developer and nurture innovative products that can offer a unique value proposition. Green Hydrogen, Green Ammonia, Lithium Ion Batteries are all cases in point.
• Service innovators will be the second category. Bank transfers have been happening in India for a long time. What change was the simplicity that the combination of wallets and united payment interface (UPI) made to this system. Today digital bank transfers have become the standard protocol in remote places, thanks to UPI.
• The third focus would be on the process innovators. If you think back, cars were also made before Henry Ford. But it was Henry Ford who devised the process innovation of assembly line manufacturing. That changed the face of the auto industry and continues to remain the paradigm for the automobile industry till today.
• Finally, there would be the innovation adaptors, who will be the downstream companies executing such innovation, or benefiting from such innovation or adding value to such innovation. This is largely about showing agility in response to change. It depends on whether these small innovations can substantively make a difference to business.

Let us quickly look at how the fund will identify such companies.

IDENTIFYING INNOVATIVE COMPANIES

That is easier said than done. However, here is a broad model that the SBI Innovations Opportunities Fund will follow. The focus will be on companies adopting AI or sustainable practices. The fund will also focus on companies with a track record of raising market share through innovation. One proxy will be to look at companies with R&D spending above a certain threshold of sales. At a more discretionary level, the focus will on companies that demonstrate speed in adapting to new technologies. It will also focus on companies making big investments in such innovative opportunities, with a focus on companies that use innovation to create sustainable competitive advantage or moat in the business.

GLANCE AT THE SBI INNOVATIONS OPPORTUNITIES FUND NFO

Here are some details of the SBI Innovations Opportunities Fund NFO you must know to decide on investing in the fund.

• The NFO of SBI Innovations Opportunities Fund opened for subscription on July 29, 2024 and will close on August 12, 2024. Being an open-ended thematic fund, with focus on innovative companies, it will reopen for sale and repurchase anywhere between 3 days and 15 days of NFO closure. The SBI Innovations Opportunities Fund is best suited to investors looking for long-term capital appreciation through a focus on innovative and new age companies, where the overall risk-reward equation if favourable. Innovative companies have product risk, but also promise higher returns in the long run.
• The core focus of the SBI Innovations Opportunities Fund is to invest in equity and equity related instruments of companies that are engaged in or companies that are expected to benefit from adoption of innovative strategies and themes. Innovation can refer to product, underlying technology or even process. The fund will look at companies with a proven execution track record of translating innovative ideas into business numbers. The focus will be on long-term capital appreciation, so a holding period of 5-7 years at the bare minimum would be required to realize the full benefits of innovation cycle.
• On the Standard SEBI Risk-O-Meter, the SBI Innovations Opportunities Fund will be ranked as a Very High Risk Fund. The high risk is an outcome of the predominant exposure to equities (80% to 100%) that the SBI Innovations Opportunities Fund will have. In addition, there is also the risk of entering equity stocks at a time when Nifty and Sensex are near lifetime highs and the P/E ratio of the index is above the long term median. Most large cap funds also have a kurtosis risk as they cannot fully focus on high performing stocks due to the 10% exposure limit to a single stock.
• The SBI Innovations Opportunities Fund is about generating capital appreciation from a smartly diversified portfolio of equity stocks of companies that satisfy the innovation criteria. The focus of stock picking will be largely capitalization agnostic. The SBI Innovations Opportunities Fund will look at an eclectic mix of large caps, mid-caps, and small caps subject to the innovation criteria being met. The fund will focus on companies where innovation can be demonstrated and practically converted into a viable business proposition with a positive long term ROI.
• Investors can invest in the NFO of SBI Innovations Opportunities Fund in minimum size of ₹5,000 lumpsum and in multiples of ₹1 thereof. Minimum monthly SIP (systematic investment plans) will have to be at ₹500 and in multiples of ₹1 thereof. This also applies to switch-ins during the NFO. The fund also supports the systematic investment plans (SIPs) and systematic transfer plans (STPs) programs to be in-built into the fund to enable larger retail participation on a continuous basis.
• While there is no entry load, there will be an exit load since this is an innovation based equity fund with a necessarily longer term perspective. Hence, early exits may be detrimental to existing unit holders. There is an exit load on redemption and switch out from the fund to the tune of 1% of NAV, if redeemed on or before 1 year from the date of allotment. Any redemption or switch out after 1 year will not attract any exit load. However, leaving aside the issue of exit loads; investors are advised to hold the fund for a minimum period of 5-7 years to get full benefits of the innovation theme that is built into the core objective of the SBI Innovations Opportunities Fund.
• The SBI Innovations Opportunities Fund does not give any guarantee on returns, being an equity oriented thematic fund, and the performance is subject to the vagaries and vicissitudes of the markets in general and the stocks selected in particular. Being an active fund, the fund will also be subjected to the risk of fund manager discretion. The SBI Innovations Opportunities Fund will be benchmarked to the Nifty 500 Total Returns Index (TRI) and the fund managers will focus on generating alpha by beating this underlying index over a longer time frame.
• The SBI Innovations Opportunities Fund will be managed by Prasad Padala and his team. The intent of the fund management team will be generate alpha by earning returns on the fund that is better than the index returns by investing in companies that satisfy the innovation criterion. Computer Age Management Services (CAMS) will be the registrars to the fund. The intent of the fund is to generate long term capital appreciation by investing in a portfolio of stocks adhering to the innovation theme.

The SBI Innovations Opportunities Fund NFO offers an opportunity for investors to participate in the high opportunity arena of innovation. This has its thematic risks, but also comes with the potential to outperform the underlying indices significantly.

TAX TREATMENT FOR SBI INNOVATIONS OPPORTUNITIES FUND

Post the Union Budget announced on July 23, 2024; there are some key changes to the way the returns earned on the SBI Innovations Opportunities Fund will be taxed. It must be remembered that, being an equity fund, it will be taxed at par with equities under the Income Tax Act. Here are the key things to know about tax treatment.

• Being an equity fund, the holding period criteria for short term and long term capital gains demarcation is 1 year. If the SBI Innovations Opportunities Fund is held for 1 year or more, it will qualify as long term capital gains. It will be short term capital gains if held for less than 1 year. It could also be capital losses for short term and long term.
• The dividends declared by the fund, if any, will be treated as other income in the hands of the investors and will be taxed at the peak incremental rates of tax applicable. In addition, if the dividends exceed ₹5,000 in a year, then they will be subject to tax deduction at source (TDS), under the extant income tax rules.
• Short term capital gains have undergone a change in the July 23, 2024 Union Budget announcement. The short term capital gains on the fund arising from units sold before 1 year of holding will be taxed at 20% of the gains plus cess at 4%, making the effect STCG rate at 20.80%. The STCG Tax rate on equities was 15% prior to the Union budget, but has since been increased to widen the gap with long term capital gains rate.
• The long term capital gains (held for over 1 year), will now be taxed at a flat rate of 12.5% (increased from 10% prior to the budget). However, the threshold exemption limit has also been increased. While the limit was ₹1 Lakh exemption annually, that has been now raised to ₹1.25 Lakhs.

Understanding taxation of large cap mutual funds is important as it is the post-tax returns that really matter from a long term financial planning perspective.