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Should you invest in the new CPSE ETF?

To find out if it's a good idea to invest in such funds, one should consider how the first CPSE ETF has been performing.

, ET Bureau|
Updated: Jan 09, 2017, 10.01 AM IST
The government is set to launch a new exchange-traded fund (ETF) based on the central public sector enterprises (CPSE) index. Managed by Reliance Mutual Fund, this will be the second CPSE ETF, the first being launched in March 2014.

The fund aims to provide investors the opportunity to invest in a diversified basket of public sector companies and benefit from the growth potential over the long term.

It will mirror the performance of the CPSE Index while the portfolio will comprise shares of the 10 biggest PSUs: ONGC, GAIL, Coal India, IndianOil, Oil India, Power Finance Corporation, Rural Electrification Corporation, Container Corporation, Engineers India and Bharat Electronics.

To find out if it's a good idea to invest in the fund, one should consider how the first CPSE ETF has been performing. When it was launched, the government had offered an upfront discount of 5% on the issue price to sweeten the deal for investors.

A year later, the government issued `loyalty' units in the ratio of 15:1 to eligible retail investors who remained invested since the new fund offer, which amounted to an additional discount of 6.66%. It is expected that the new CPSE ETF will also offer similar discounts and bonus, providing an attractive entry point for retail investors. The low valuations of the underlying shares also make it a compelling offer--the stocks that form the CPSE ETF are trading at a much lower Price to Earnings (PE) ratio and have higher dividend yields than the broader market.

While the CPSE Index trades at a PE multiple of 11.44 and dividend yield of 4.07%, the Nifty 50 index is available at 22 times and 1.35% respectively .A low expense ratio of 0.065% also ensures that costs do not eat into the gains made by the scheme over time.

The ETF claims to offer investors a play on the India growth story through a diversified basket of PSU stocks. But a closer inspection of the composition of the underlying index suggests that the portfolio is far from diversified. Three stocks--ONGC, Coal India and IndianOil--together constitute around 63% of the entire portfolio. The portfolio is also skewed towards a few sectors, with energy, metals and financial services making up 90% of the portfolio. This lends a higher risk element despite the fact that the stocks are some of the biggest names in their respective sectors.

The performance of the first CPSE ETF has been impressive. Since its inception, the fund has clocked 14.5% annualised return while the Nifty 50 index gained 7.5% during the same period. After adjusting for loyalty units, retail investors have made a gain of 17.2%. Over the past year, the fund delivered 17.43% return even as the Nifty 50 index clocked 2.8%.

This effectively makes it the best performing large-cap fund. But this performance needs to be put in context. The fund reached its peak NAV within two months of launch supported by factors such as government oil price deregulation and a fall in crude prices.

Investors also believed that the efficiency of public sector companies would improve under the Modi government. As Kunal Bajaj, CEO, Clearfunds, point out, the fund's returns have been driven by commodity price trends as the index is skewed towards commodity businesses.

Experts are of the opinion that this is more of a speciality fund, rather than a typical diversified equity fund, and should be regarded as such. “Investors should treat this as a sector or thematic fund and invest accordingly. That means it should not be a part of your core allocation. You can opt for partial allocation within the 10% tactical allocation in the portfolio,” suggests Amol Joshi, Founder, PlanRupee Investment Services.

Another factor to consider is that any changes in the policies of the promoter could have a bearing on the entire basket. “Retail investors should not over-expose their portfolio to such a concentrated bet,” warns Bajaj, adding that since the fuel price hike and deregulation is mostly behind us, there aren’t too many things the government can do to help the stock prices of these energy PSUs.

Besides, while the lower valuations for the underlying PSU stocks provide some comfort on the downside, they are cheap for a reason, points out Joshi. Most private sector businesses in the respective sectors are run far more efficiently, and are therefore awarded expensive valuations. While the likely discount and loyalty bonus makes it an attractive proposition, you should invest in the CPSE ETF only if you think the underlying businesses have growth potential and intend to hold on to it over the long run.

(Story updated on January 7, 2017.)

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