Should you invest in CPSE ETF follow on offer?

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The Government of India is coming out with Further Fund Offer (FFO) of CPSE ETF. FFO opens on January 18, 2017 and closes on January 20, 2017. The Government plans to raise Rs 4,500 crores with an option to retain over-subscription up to Rs 1,500 crores.

Should you invest in follow on offer of CPSE ETF? Let’s discuss the various aspects.

What are Exchange Traded Funds (ETFs)?

ETFs are similar to index funds. ETFs are passively managed (just like index funds) and try to replicate performance of a benchmark index. To do that, ETFs try to hold securities in same ratio as the underlying index.

Major difference is that you can buy or sell index fund units only at day’s closing NAV (just as for any mutual funds). ETF units are listed on exchange and can be bought throughout the day like a stock. Do note, since you purchasing from secondary market, liquidity in that particular ETF can impact your purchase or redemption price. Low liquidity can result in higher impact cost.

What is CPSE ETF?

CPSE ETF is benchmarked against Nifty CPSE Index. Hence, the ETF will try to replicate composition of Nifty CPSE Index. There can be tracking error due to ETF expenses, cash balances etc.

Through the CPSE ETF, you can take exposure to following ten public sector units through a single instrument.

  1. ONGC India Ltd.
  2. Coal India Ltd.
  3. Indian Oil Corp Ltd.
  4. Power Finance Corporation
  5. Rural Electrification Corporation Limited
  6. Container Corp of India Ltd.
  7. Bharat Electronics Ltd.
  8. Oil India Limited
  9. Engineers India Limited
  10. Container Corporation of India Limited

The ratio in which these companies are held in CPSE ETF is based on composition of Nifty CPSE Index.

What will be the price?

Purchase price will be average of the full day volume weighted average price of the constituents of Nifty CPSE Index on NSE during Jan 18 and Jan 20. Sounds confusing?  Ignore it. Consider it will be around the prevailing price (NAV) of CPSE ETF unit.

Salient Features of FFO of CPSE ETF

  1. Retail investors get an upfront discount of 5%.
  2. Minimum investment amount for retail investors is Rs 5,000. You can invest in multiples of Re 1 thereafter up to a maximum of Rs 2 lacs. If you invest more than Rs 2 lacs, you won’t be considered a retail investor and will not be eligible for discount of 5%.
  3. Expense ratio of the ETF is 0.065%
  4. The units will be listed on BSE and NSE on or before February 10, 2017. Hence, you can exit in the secondary market.
  5. You will have to pay regular brokerage charges while selling ETF units.
  6. CPSE ETF will get tax treatment of equity shares or equity MF units. Capital gains resulting from sale of ETF units within 1 year will attract capital gains tax of 15%. Long term capital gains (holding period > 1 year) will be exempt from income tax.

Performance of CPSE ETF

CPSE ETF was launched only in March 2014. The allotment price was Rs 17.45 per unit. The NAV as on January 12, 2016 was 26.832.  That is approximately a return of ~ 17% per annum.

This is better than not only the broader benchmark indices (Nifty and Sensex) but also ahead of the some of the best performing large cap funds.

Is there a guarantee that such outperformance over Nifty or large cap funds will continue? No, there is not.

CPSE ETF vs. Actively Managed Mutual Fund

It is like comparing apples and oranges.

CPSE ETF is quite different from an actively managed mutual fund. You will always have the same set of stocks under this ETF. Composition will change only in case of change in the underlying Nifty CPSE Index.

Under an actively managed mutual fund where stocks you own (as an investor in the scheme) will change depending upon the fund manager’s outlook.

Many argue that the expense ratio is quite low in case of CPSE ETF as compared to actively managed funds. However, active management brings in additional cost and that reflects in higher expense ratio.

Government Largesse?

CPSE ETF was first issued in March 2014. Retail investors got a discount of 5% that time too. In addition, a year later, the Government announced a bonus of 1 ETF unit for every 15 units held. This “loyalty” bonus was offered only to those who had remained invested in CPSE ETF since the new fund offer (NFO).

Unlike MF or stock bonuses, where the bonus is paid out of your capital only (hence bonus only in name), CPSE ETF was actually a bonus. For instance, if you hold 15 units of MF scheme and NAV is Rs 100, your investment value is Rs 1,500. If AMC announces a bonus of 15:1, you will get an additional unit for every 15 units held. So, you will have 16 units. However, NAV of the scheme will adjust accordingly. New NAV will be Rs 93.75. Effectively, the value of your investment will be Rs 1,500 only.

However, in case of CPSE ETF, Government transferred shares from its kitty to eligible investors (through ETF). Hence, if you held 15 units at Rs 100 each, you will get an additional unit but the ETF NAV does not change. So, your investment value becomes Rs 1,600. Your Rs 1,500 actually became Rs 1,600.

Can you bank on such Government largesse again? I don’t know. That’s anybody’s guess.

Is CPSE ETF really diversified?

Here is the composition of CPSE ETF as provided on Reliance AMC website. Reliance Nippon Life Asset Management Limited manages the ETF.

invest in CPSE ETF Nifty CPSE index
Source: Reliance AMC website

If you add the numbers, metal and energy stocks make up over 75% of the index. Hence, fortunes of CPSE ETF investors will be heavily tied to commodity prices. I do not see much of diversification here.

What should you do?

Do not fall merely for the hype.

If you believe that the underlying public sector units (that comprise CPSE ETF) are likely to perform well in the future, CPSE ETF is a good way to take exposure to the PSU basket. Your optimism could be due to positive outlook for the respective sectors/companies or due to favourable Government policies or due to any other reason.

Consider it akin to investing in a stock. You must believe that these very stocks have to do well in future. Of course, that you are investing in multiple PSUs through this ETF diversifies your bet to an extent. Do consider composition bias towards metal and energy stocks.

Retail investors get an upfront discount of 5%, which sweetens the deal for the retail investors.

I am not an expert on stock valuation and hence will not comment about whether the valuation is attractive at this time.

If you are planning to invest, invest only a small amount of your overall portfolio.

If you are not sure about future performance, stick to an actively managed large cap fund.

Additional Links

  1. CPSE ETF on Reliance AMC website
  2. Nifty CPSE Index Methodology

13 thoughts on “Should you invest in CPSE ETF follow on offer?”

  1. Prabhakara Rao Seeram

    Good article Mr. Deepesh. Given the current low commodity prices and blue chip psu stocks valuation at 5% discount, it looks attractive for many retail investors.

    1. Hi Prabhakara,
      My limited experience in equity markets tells me that stock price outlook is never so simplistic.
      You might feel that the commodity prices are down. However, the prices may still go down. We witnessed how crude kept forming newer and newer over the last few years. We also need to see if these companies will be able to get benefits of lower prices and to what extent.
      But yes, if you have faith in your research, the reason for investing in the CPSE ETF becomes quite compelling.

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