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CPSE ETF’s 6th FFO opens soon. Should you invest

Jan 28, 2020


The FFO (further fund offer) of Central Public Sector Enterprises Exchange Traded Fund (CPSE ETF) will open to retail investors on 31 January. An ETF is a type of mutual fund whose units are, typically, bought and sold on a stock exchange using a trading account rather than from the fund house. This is the sixth tranche of CPSE ETF ever since its launch in March 2014.

What is it?

CPSE ETF is a collection of 12 public sector companies, mostly in the energy and power sectors. It has delivered compounded annual growth rate (CAGR) of -6.36%, -6.35% and -2.59% over the past one, three and five years, respectively, as on 23 January, according to data from Value Research.

Each CPSE ETF tranche comes with a discount, which have historically been in the range of 3-5%. The current tranche is offering a discount of 3% to all investors. The discount is on the reference price, which is the volume weighted average price of the stocks comprising the ETF on 31 January. A large group of investors (largely institutional) tend to invest in the ETF only to grab the discount. These investors exit shortly after getting units at the discounted price.

The CPSE ETF is benchmarked against the Nifty CPSE Index. Earlier, the index had 10 constituents, which increased to 12 after it was rejigged in January. The criteria of including constituents have also changed slightly. Earlier, companies with a government stake of more than 51.5% were eligible; the limit is now down to 51%. About 60% of the ETF comprises of Power Grid Corp. Ltd (20.59%), Oil and Natural Gas Corp. (19.69%) and NTPC Ltd (19.66%).

According to Nippon India Asset Management Co., which manages CPSE ETF, it is a play on India’s growth story through large CPSE stocks with favourable valuations. The companies are well-established in their sectors and enjoy close to monopoly status, said a company presentation. The ETF’s expense ratio is 0.0095%, it added.

Should you invest?

ETFs insulate themselves from fund manager error by passively tracking an index. On the flip side, they give up on the idea of outperformance. However, the advantage of index investing is less apparent for a custom-built index such as the Nifty CPSE Index than it is for a broad-based index like the Nifty or Sensex. Broad market capitalization-based indices automatically filter out stocks that lose market-cap and vice-versa. This is not true for custom-built indices.

“Those who want passive funds should go for diversified ETFs such as those pegged to Nifty, Nifty Next 50 or even Nifty Mid Cap 100,” said Prateek Pant, co-founder and head of products and solutions, Sanctum Wealth Management Pvt. Ltd.

Experts have warned individuals against investing in CPSE ETF due to its highly concentrated nature with only a few stocks in the basket. “While there has been a rejig in the CPSE Index, the concentration is in 12 stocks (with 4-5 of them making about 75% of the index). The ETF is also heavily exposed to the energy industry, which is highly cyclical. Even seasoned investors tend to stay away from such concentration. So for retail investors, such a basket shouldn’t be on the radar,” said Nithin Sasikumar, co-founder, Investography Pvt. Ltd, a financial planning firm.

“The global environment is shifting from risk-on to risk-off due to the potential impact of the corona virus. Global commodity and energy prices are getting impacted negatively. In this environment, it may not be advisable to invest in an energy- and commodity-heavy ETF despite attractive valuations and a discount,” said Gaurav Awasthi, senior partner, IIFL Wealth Management Ltd.

Experts also caution against the government ownership of CPSE ETF. “Government ownership of such companies leaves limited room for independent thinking and professional management,” said Deepali Sen, founder, Srujan Financial Advisors Llp. “Government ownership has not usually rewarded investors with a long-term buy-and-hold approach relative to privately-run companies. Since these ETF divestments aren’t really bringing a strategic investor at the helm of a company, there isn’t a value addition for the company or investors,” said Sasikumar.

For those who are considering the ETF for a short-term trade, experts have warned about the transaction costs and rapid price movements that can take out profits. “We have consistently regarded CPSE ETF as a suboptimal option for retail investors. The 3% discount is not a large enough arbitrage and will be partially eaten up by transaction costs such as brokerage and tax,” said Pant.

Gains on equity ETF units held for less than a year are taxed at 15% (short-term capital gains tax) and gains on ETFs held for longer are taxed at 10% (long term capital gains tax). In case of the latter, gains up to ₹1 lakh per year are tax-exempt. “Also, retail investors may not be able to sell units quickly enough after getting allotment. They should avoid any kind of short-term discount trade. That is more for qualified institutional investors,” he added.

The past returns of CPSE ETF do not contradict the opinion of experts. All in all, this ETF is a product best avoided.

Source: livemint