PSU Thematic Funds: A Tactical Play on Government-Led Growth

In this cover story, we explore the potential of PSU-themed Mutual Funds, offering investors a chance to tap into government-backed sectors. Abhishek Wani analyses their long-term growth, sectoral weightage, and key drivers such as reforms and fiscal tailwinds[EasyDNNnews:PaidContentStart]

In the ever-evolving landscape of equity investing, Public Sector Undertakings (PSUs) have consistently played a crucial role in India's economic growth story. Amidst evolving government reforms and rising macroeconomic optimism, PSU-themed Mutual Funds have attracted increasing attention. These funds offer investors a unique opportunity to tap into the growth potential of government-backed sectors. However, as with any cyclical asset, the performance of PSU stocks can fluctuate. Understanding their valuation dynamics is vital for making informed investment decisions. In this cover story, we examine the performance of PSU-themed mutual funds, assess their current potential using mean reversion analysis, and provide actionable insights for investors navigating this investment space.

PSU Fund Performance: Riding the Reform Wave
PSU-themed funds have shown consistent long-term growth, despite some short-term challenges. As of September 2025, key PSU equity schemes, including SBI PSU Fund and ICICI Prudential PSU Equity Fund, have demonstrated strong three-year compounded annual growth rates (CAGR) of 32.64 per cent and 29.73 per cent, respectively. However, both funds faced slight declines in the past year, with SBI PSU Fund posting a -2.12 per cent return and ICICI Prudential PSU Equity Fund returning -4.16 per cent.

Other funds, such as Invesco India PSU Equity Fund, have shown solid long-term growth, reporting a 32.63 per cent CAGR over the last three years despite a -1.77 per cent dip in the past year. These figures highlight the ability of PSU-themed funds to generate strong long-term growth, especially during times of structural reforms and macroeconomic recovery. For comparison, the BSE Sensex posted a return of -3.71 per cent over the last year, with a 10.14 per cent CAGR over three years, illustrating the relative outperformance of PSU funds.

Sectoral Weightage of PSU-Themed Funds
PSU-themed mutual funds focus their investments across a few key sectors that drive the performance of these funds. The following table shows the sectoral weightage for top PSUthemed mutual funds:

Key Sector Insights
■ Financial Services: Approximately 36 per cent of AUM in PSU funds is allocated to the financial services sector, predominantly in PSU Banks. These banks benefit from governmentbacked consolidation, creating stronger, larger entities with improved credit growth trajectories. With rising credit demand and improving asset quality, PSU banks remain central to PSU funds' long-term growth.

■ Energy Sensitivity: The oil, gas, and consumable fuels sector makes up around 24.5 per cent to 34.5 per cent of fund allocations. Quant PSU Fund, for instance, has 34.49 per cent of its AUM in this sector, capitalising on energy demand and refining margins. However, exposure to this sector comes with inherent commodity price risks, particularly in volatile global oil markets.

■ Cyclical Growth in Power & Capital Goods: Exposure to the power sector is moderate, with funds like Invesco India PSU Equity Fund allocating 26 per cent to this sector. The sector benefits from strong government capital expenditure (capex), specifically in energy generation and transmission. Invesco has 25.86 per cent exposure to capital goods, capitalising on rising demand for infrastructure projects, particularly in Defence and Railways.

The Cyclical Rally: Key Drivers of Performance
The PSU stock rally has been driven by a combination of government policies and favourable macroeconomic factors. Several key drivers contributing to the performance of PSU stocks include:

■ Government Reforms: The PSU banking sector has benefited from government-led consolidation and reforms. With stronger banks, capital positions are improving, boosting credit growth. Similarly, large infrastructure and energy PSUs have gained from record government capital spending.
■ Fiscal Tailwinds: The government's focus on infrastructure development, defence spending, and energy transition has provided a substantial tailwind to PSU stocks. The national infrastructure pipeline continues to channel significant resources into roads, Railways, and energy.
■ Cyclical Upside in Banking & Energy: Both the banking and energy sectors are benefiting from postpandemic economic recovery. PSU banks are seeing record profits, driven by increasing loan growth and improving asset quality.
■ Privatisation and Disinvestment: Ongoing privatisation and disinvestment efforts by the government, including stake sales in IDBI Bank and BPCL, have further boosted PSU stocks, expected to infuse capital and improve governance.

Sectoral Drivers of PSU Fund Performance
Several key industry-specific factors are driving the performance of PSU-centric portfolios:

■ Banking: Consolidation among public-sector banks (PSBs) has resulted in stronger capital positions and better net interest margins. The credit growth in the banking sector is expected to continue, with PSU banks projected to achieve loan growth of over 14 per cent in FY2026. The capital infusion through PSU bank IPOs is expected to further improve their market position.
■ Energy & Oil: PSU oil and gas majors like Indian Oil and Bharat Petroleum are benefitting from stable refining margins and strong domestic demand. Government policies promoting green hydrogen and open acreage licensing are expected to provide further tailwinds to this sector.
■​​​​​​​ Defence and Aerospace: The government's ‘Aatmanirbhar Bharat’ push has resulted in substantial Order Books for defence PSUs such as Hindustan Aeronautics Ltd. (HAL) and Bharat Electronics Ltd. (BEL). These companies are expected to continue their upward trajectory as the defence modernisation drive picks up steam
■​​​​​​​ Infrastructure: High government spending on roads, highways, and railways continues to benefit PSU contractors like IRCON and NHAI. The Centre’s capex target of 3.5 per cent of GDP should further propel the growth of infrastructure PSUs.

The Outlook: Should Investors Ride the PSU Rally?
The outlook for PSU stocks remains optimistic but cautious. While analysts see favourable long-term growth prospects due to government reforms, the market has priced in many of these gains, leading to concerns over potential overvaluation.

Market experts remain bullish on PSU stocks, driven by structural reforms, government spending, and robust growth prospects in sectors like banking, energy, and infrastructure. There are record profits in PSU banks and strong order books in defence and infrastructure. Similarly, many PSUs now boast strong ROE and ROCE, indicating sustainable growth potential. Despite the optimism, caution remains due to elevated valuations in the banking and energy sectors. Many PSU banks are now trading near their 5-year highs, suggesting limited upside unless earnings surprise to the upside.

Additionally, risks such as global commodity price volatility and fiscal constraints could dampen the short-term outlook for PSU stocks.

Investor Sentiment and Inflows

Investor Sentiment and Inflows The July 2025 surge was largely driven by new fund offers (NFOs), which sparked significant investor interest in sectoral funds. However, August 2025 saw a slowdown due to profitbooking and redemptions, indicating a shift towards more cautious investment behaviour.

BSE PSU Index vs. Sensex: A 20-Year Overview
Over the past two decades, the BSE PSU Index has demonstrated strong cyclical performance, often outperforming the broader Sensex during key periods of government-driven reforms. These include fiscal changes such as privatisation, increased infrastructure spending, and capital infusion into public sector companies. However, the sector has also faced notable corrections, particularly during global economic uncertainty or shifts in policy.

Key Insights:
■​​​​​​​ Long-term Growth: The BSE PSU Index has consistently outpaced the broader market, particularly following fiscal reforms like infrastructure investments and privatisation. Government-led stimulus in sectors such as banking, energy, and defence has led to longterm growth.
​​​​​​​■​​​​​​​ Recent Performance: In FY2024, the PSU sector saw an impressive 36 per cent surge, driven by favourable fiscal policies and macroeconomic recovery. However, this was followed by an 11 per cent correction in early FY2025, reflecting the cyclical nature of PSU stocks. This suggests that while the sector can outperform in growth periods, it can also experience short-term corrections.

Chart: BSE PSU Index vs. Sensex (2005-2025)

Mean Reversion & Z-Score Analysis: Assessing PSU Sector Valuation
Over the last two decades, the Nifty PSU Index has demonstrated periods of strong outperformance, particularly during economic recoveries supported by government-led reforms and capital expenditure (capex). However, PSU stocks are cyclical and can underperform during global uncertainties or policy shifts. To assess whether the PSU sector is currently overvalued or undervalued, we utilise mean reversion analysis and Z-score calculations, based on the Nifty PSU / Nifty 50 ratio.

Z-Score Analysis: Current Data and Interpretation
For September 1, 2025, the Nifty PSU / Nifty 50 ratio stands at 4.12, with a historical mean of 3.84, and a standard deviation of 1.77. The resulting Z-score of 0.16 suggests that the PSU sector is mildly overvalued relative to its historical performance. While this does not indicate severe overvaluation (a Z-score above +1 would), it does signal caution, as the PSU sector has recently outperformed the broader market by a small margin. Investors may consider waiting for a market correction before initiating new positions, or closely monitoring sectoral trends for any signs of reversion to the mean.

Comparing the BSE PSU Index with the Sensex over the last 20 years reveals the sector’s cyclical nature
■​​​​​​​ Since 2020, the BSE PSU Index has outperformed the broader market, driven primarily by fiscal stimulus and government policy support, especially following significant fiscal changes such as privatisation and increased infrastructure spending.
■ In FY2024, the PSU sector surged by 36 per cent, but in early FY2025, it faced an 11 per cent correction due to profit-taking. This reflects the cyclical nature of PSU stocks, where periods of strong growth are often followed by retracements.

Conclusion
PSU-themed mutual funds have shown strong performance in recent years, driven by government reforms and growth in sectors like banking, energy, and infrastructure. With the sector benefiting from privatisation, disinvestment, and fiscal support, PSU funds offer appealing long-term growth potential.

However, current valuations are slightly above historical averages, signalling a need for caution. The Z-score analysis indicates the PSU sector is mildly overvalued, suggesting the potential for a short-term correction. Long-term investors can consider SIPs to capitalise on structural growth in key sectors, while tactical investors should monitor for corrections and enter when undervaluation signals appear.

The future outlook for PSU funds remains promising, backed by favourable government policies and cyclical recovery, particularly in banking and energy. Despite the sector’s strong prospects, high valuations, especially in banking and energy, suggest the need for caution. Diversification is essential to managing risk, as overexposure to cyclical sectors could lead to volatility.

In conclusion, while PSU funds offer significant growth potential, investors must remain alert to short-term fluctuations and carefully assess risk-reward scenarios before making large allocations. Monitoring for corrections and sectoral trends will guide strategic entry and exit decisions.

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