(Please check update dated 17Jan2017 on CPSE ETF)
Investment Case Against CPSE ETF:
If
you invest in this ETF, your money will be vulnerable to concentration risk.
This ETF invests in stocks of only 10 companies. Tracking the CPSE index, about
60% of your money will be deployed in only four stocks, namely, ONGC, Gail
India, Oil India and Indian Oil Corporation. All these four stocks belong to
oil & gas sector. The first three companies have been bearing subsidy
burden of government’s oil marketing companies (OMCs)—BPCL, HPCL and IOC for
several years.
All
these companies are owned by Government of India (GOI). The ETF performance
will depend on the whims and fancies of ruling politicians and bureaucrats.
With
only 10 stocks, we cannot call this ETF a diversified fund. Having only 10 stocks,
that too all from the public sector, in an ETF is completely against the
principles of diversification. An ETF is basically an investment vehicle that
pools money, invests in a basket of securities and trades like a stock on a
stock exchange.
When
it comes to corporate governance rules, GOI has got a poor track record. Quite
often, government’s actions are not guided by the interests of minority
shareholders. In the past they have used public sector companies to meet their
own political interests.
Recently,
GOI has been encouraging cross holdings among public sector companies. A few
days back, ONGC and Oil India picked up 10% stake in IOC. LIC of India has been
buying stakes in BHEL, ONGC and others at the behest of GOI. Such arm-twisting
on the part of GOI is not good for LIC policyholders also. This will complicate
the valuation of public sector entities and it is not in the interests of
minority shareholders of PSUs.
In
the last few months, GOI has forced Coal India (about Rs 16,500 crore), NMDC
and public sector banks to declare large dividends to fill up its coffers,
instead of allowing the companies to invest in profitable avenues.
This
ETF will bear a lot of political risk. Government is very weak in setting
policies and implementing them effectively. Though some form of autonomy is
given to PSUs, overall control is done by respective ministries. The overall
management of these companies continues to remain weak despite the companies
having some inherent strengths.
Most
of the companies in the CPSE index are from natural resources sector. This
sector has been imperiled by lack of environmental clearances and regulatory
risks. Even though Coal India is a monopoly, it is bedeviled with fuel supply
agreements, imposed by the Government.
Features:
The
Composition of CPSE Index:
Company Name
|
Sector
|
Weight
%
|
Company Name
|
Sector
|
Weight
%
|
|
Oil & Natural Gas
Corp
|
Energy
|
26.72
|
Indian Oil Corp
|
Energy
|
6.82
|
|
GAIL (India) Ltd
|
Energy
|
18.48
|
Power Finance Corp
|
Financial Servcs
|
6.49
|
|
Coal India Ltd
|
Metals
|
17.75
|
Container Corp of
India
|
Services
|
6.40
|
|
Rural Electrification
Corp
|
Financial Servcs
|
7.16
|
Bharat Electronics
|
Manufacturing
|
2.00
|
|
Oil India Ltd
|
Energy
|
7.04
|
Engineers India
|
Construction
|
1.13
|
Source: GSAM
The
CPSE ETF is managed by Goldman Sachs Asset Management (GSAM). This is an
open-ended exchange traded fund. The new fund offer (NFO) for retail investors
opened on 19 March 2014 and closes on 21 March 2014. The scheme will be listed
on the BSE/NSE next month. After listing on BSE/NSE, investors can buy and sell
these units throughout the market hours through their trading account with a
broker, just like they trade any listed stock. The ETF will track the CPSE
index. Entry and exit load are nil. Minimum amount of subscription is Rs 5,000
per application for retail investors.
The
GOI wants to raise a maximum of Rs 3,000 crore through this ETF from retail and
other investors. The GOI proposes to allot units at a 5% discount during the
NFO. Moreover, it proposes to give, after one year, bonus units for those who
invested in the NFO and stayed with their units for at least one year. The
scheme is in compliance with the Rajiv Gandhi Equity Savings Scheme (RGESS),
which has tax deductions subject to certain conditions.
As
the ETF units are traded like stocks on exchanges, adequate liquidity is
available for retail investors having demat accounts. The expense ratio of the
fund is 0.49%, which is very low compared to other ETFs available in India.
Return Expectations:
How
much return can one expect from this ETF? As you are aware, stocks do not offer
any guaranteed return. Returns are a function of company’s business prospects,
investor sentiment and liquidity in stock markets.
Foreign
institutional investors (FIIs) are big investors in Indian equities. Of late,
they have been showing preference to invest more in private sector companies
rather than PSUs. At present, investor sentiment is generally upbeat about
Indian equities.
Given
that public sector companies are good in paying dividends, PSUs enjoy dividend
yields of up to 4%, much higher than their private sector counterparts. The PSUs
may not go bankrupt given the government’s implicit sovereign guarantee, but the
GOI may allow certain companies (e.g., Air India, BSNL) to bleed as long as
possible. Even with schemes like US-64 that was run by the then state-owned and
unregeulated Unit Trust, investors lost heavily.
However,
as happened in 2008 and 2009, PSUs with good balance sheets typically do well
when stock markets are afflicted with global crises.
There
is this narrative going round that one can buy these units in NFO and sell them
after one year to earn a return of about 11 percent without any risk. My
question is if everybody wants to sell these units after one year, who will buy
from you? Remember Reliance Power IPO during the 2008 stock market peak when
investors and speculators lost heavily in the IPO because everybody wanted to
sell and there were no buyers?
Why an ETF with only 10 stocks?
It’s
strange that the capital markets regulator SEBI allowed an ETF to be floated
with just 10 stocks. Is it because as an arm of the GOI, they cannot say no to the
all-powerful state? I’ve a rhetorical question, will SEBI allow an ETF to be
launched with just 10 stocks in the private sector? Even insurance regulator IRDA
allowed insurers to invest in this highly concentrated ETF. It’s very strange
that the regulators want to be a party to the government’s efforts to raise
money for their fiscal profligacy.
Why
cannot the GOI introduce an ETF that consists of 30 or 60 PSU stocks from a
variety of industries and sectors?
Final Words:
Reports
suggest that anchor investors invested about Rs 850 crore in this ETF fund
yesterday. Institutional investors have sophistication and they are supposed to
be masters in risk mitigation. What is suitable for them may not be suitable
for retail investors.
The
CPSE ETF has completely failed as an investment case when you consider the
principles of risk mitigation and diversification. The fund is not adequately
diversified to provide any cushion during market meltdowns. The concentration
risk is very high and non-sophisticated investors may find the fund too risky
for their equity portfolios.
But
I would like to add that I’m not telling you not to consider the stocks of PSUs
individually. Depending on your risk appetite and portfolio management
perspective, you can definitely consider individual PSU stocks provided you’ve
done your own research on these companies and they’re suitable for your
investment objectives and goals. While evaluating, please take into account all
your investments—direct equities, equity mutual funds and ULIPs—as a total
package.
My
sincere view is that investors should allocate money towards equities as per
their long-term financial plan, asset allocation and risk profile. Making
individual investments ignoring the fundamental principles of personal finance
will not help you.
You
should not be solely guided by tax benefits or sops (like 5% discount and bonus
units in this case) while making serious investments.
While
making investments, first see if you have any surplus money, whether the
investment offers any return, convenience, liquidity and downside protection. The
bottom line is that the CPSE ETF does not offer any diversification, nor does
it offer any downside protection.
Unsophisticated
retail investors are better off with time-tested index funds, tracking Nifty
50, Junior Nifty or BSE 200 index or some large-cap well-diversified mutual
funds with long-term track record that are available in the market.
Related Articles:
Notes:
CPSE
ETF – Central public sector enterprises’ exchange traded fund
GOI
– Government of India
GSAM
– Goldman Sachs Asset Management
NSE
– National Stock Exchange
SEBI
– Securities and Exchange Board of India, the capital market regulator
PSU
– Public sector undertakings or public sector enterprises or state-owned
enterprises
ULIPs
– Unit-linked insurance plans that typically invest in stocks
Disclosure:
Don’t own any shares in the above stocks. But I own a few shares in a few PSUs.
Disclaimer:
The information provided is only for information purposes and should not be
construed as investment advice. Investors should consult their own financial
advisers before making any investments. The author is an investment analyst
with a vested interests. He blogs at:
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