CPSE ETF

Government of India has announced the CPSE(Central Public Sector Enterprises) index fund. Managed by Reliance Mutual Fund, this will be the second CPSE ETF by the Government of India...Read on to find whether it is worth getting into it?

Intro to CPSE Fund
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, Indian Oil, Oil India, Power Finance Corporation, Rural Electrification Corporation, Container Corporation, Engineers India and Bharat Electronics.

Composition of CPSE Fund
Let us first understand the composition of various companies in this fund. Below is the list of companies included in this fund along with their weight-age of shares in the fund.

Investment Strategy of the fund
The fund will invest into stocks, which are the constituents of Nifty CPSE Index, in the same proportion as the Index. The stocks included in this index must fulfill the following parameters. 
1) Be a part of the list of CPSEs published by the Department of Public Enterprise.
2) Be Listed at National Stock Exchange of India Ltd (NSE).
3) Have more than 55% Government Holding under promoter category.
4) Have average Free Float market capitalization of more than INR 1000 crore for six month period ending June 2013.
5) Have paid dividend of not less than 4% including bonus

How did the first round go?
The performance of the first CPSE ETF launched in 2014, was undoubtedly 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. There was also a belief that the efficiency of public sector companies would improve under the Modi government. The fund's returns have been driven by commodity price trends as the index is skewed towards commodity businesses.

What works in its favour?
1) Expect an upfront discount of 5% on the issue price to sweeten the deal for investors, just like in the first offering.
2) Sometime later, expect the government to issue`loyalty' units to eligible retail investors who remain invested.
3) 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.
4) Since it is an index fund with no active management, the expense ratios are low. A low expense ratio of 0.065% also ensures that costs do not eat into the gains made by the scheme over time.
5) The ETF claims to offer investors a play on the India growth story through a diversified basket of PSU stocks.

What goes against it?
1) A closer inspection of the composition of the underlying index suggests that the portfolio is far from diversified.
  a) Three stocks--ONGC, Coal India and Indian Oil--together constitute around 63% of the entire portfolio.
  b) The portfolio is also skewed towards a few sectors, with energy, metals and financial services making up 90% of the portfolio - Energy making it close to 60% of the entire portfolio.
This "undiversified" nature of the fund lends a higher risk element despite the fact that the stocks are some of the biggest names in their respective sectors.
2) This is more of a sector or a thematic fund, rather than a typical diversified equity fund, and should be regarded as such. That means it should not be a part of your core allocation. You can opt for partial allocation if you have confidence in the future of India PSUs
3) Being mostly an industry specific fund, any changes in the policies of the promoter could have a bearing on the entire basket.
4) 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.

Summary
While the lower valuations for the underlying PSU stocks provide some comfort but they are cheap for a reason. 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.

Our take
From our side, we are avoiding this fund. Rather, we would encourage investing your surplus in properly diversified mutual funds or select stocks that add balance to your existing portfolio.

Cheers

Manoj Arora
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