Why I Won't Invest in the FFO of the CPSE ETF - 17Jan2017

Why I Won't Invest in the Further Fund Offer of the CPSE ETF:

 

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(Previous blog dated 19Mar2014 on CPSE ETF)

The Government of India has come out with a further fund offer (FFO) of the CPSE exchange traded fund or CPSE ETF, which is managed by the Reliance Nippon Life Asset Management Ltd or Reliance Mutual Fund. This FFO opens on 18 January and closes on 20 January 2017 for non-anchor investors. The government wants to raise Rs 4,500 crore (with a green shoe option of another Rs 1,500 crore) from this offer.

Here I briefly analyse of the offer of the units of CPSE ETF and I'm giving my reasons why I will not invest in this further fund offer of CPSE ETF:

1. High Concentration Risk:

There are only ten stocks in the CPSE ETF mutual fund. All of them belong to the public sector known as central public sector enterprises or CPSEs. Top four stocks account for around 74% of total value of the fund. Such high concentration is vulnerable to greater risks and against the principles of diversification. As noted, the performance of the ETF depends mostly on four PSUs (public sector undertakings), namely, ONGC, Coal India, IOC and GAIL.

Even among sectors there's little diversification. Energy sector (oil, gas and minerals) accounts for 77% of the total value, which is not desirable. Financial services is one of the high growth sectors in India, but this ETF has only less than 11% exposure to this sector.

The natural resources sector is not a growth sector in India, though these companies have huge assets and some of them are in monopoly businesses. It's inexplicable how the market regulator SEBI has allowed such an ETF with just 10 stocks, all belonging to the public sector, with high exposure of 77% to natural resources sector.

2. Indian Government Is a Bad Manager:

As is widely known, governments in India are known to arm-twist PSUs to suit their political and social needs, crippling the ability of the management of the companies to deliver decent performance. Every year, the Government forces these companies to declare higher dividends (ignoring the internal needs of the individual companies for capital expenditure) to bridge government's recurring fiscal deficit.

The Comptroller and Auditor General of India (CAG) brings out a yearly report on the central public sector enterprises (CPSEs), pointing out the poor performance and resource allocation of them. PSU stocks have greater political risk.

3. Price Risk:

The FFO will open on 18 January and closes on 20 January 2017 for non-anchor investors. The price for new investors will be based (after 5% discount) on the average price of CPSE ETF during the three days offer period (that is, 18-20 January 2017).

The Reliance Nippon Mutual Fund has indicated the new units of the current offer are likely to be listed on NSE and BSE by 10 February 2017. The new investors in FFO of CPSE ETF will have to bear price risk between the investment date and FFO allotment date for about 20 days.

In between, we've Union Budget on 1st of February, which is expected to give some surprises for stock markets. The NAV of the CPSE ETF is likely to be impacted by this event.

4. Past Performance:

Government of India seems to have timed the FFO of CPSE ETF very well. The last one-year return of the CPSE ETF is 32% as compared to 14% for the Birla Sun Life Nifty ETF fund. This performance has to be seen in the context of minus 20% delivered by this CPSE ETF in one year prior to that. As PSU stocks were beaten down during Jan2015-Jan2016 period, the return of the CPSE ETF looks superior in the last one year. But when you look at the last two years performance, the extra return of the CPSE ETF is not much.

	CPSE ETF	Birla SunLife Nifty ETF
From 17Jan2016 to 17Jan2017	32%	14%
From 17Jan2015 to 17Jan2016	- 20%	- 11%
From 17Jan2015 to 17Jan2017	5.6%	1.5%

To use a cliche, past performance of a mutual fund is no guarantee of future performance. It's a different matter whether the current offer will be suitable for new investors.

5. Any Alternatives to this CPSE ETF?

Two mutual funds are available that invest in PSU stocks--they are Invesco India PSU Equity fund and SBI PSU fund. They hold around 20 PSU stocks in their portfolios, with about 50% exposure to natural resources sector. Even these two funds cannot be called as diversified funds.

To Sum Up:

Investments in equities have to be made based on one's risk appetite, one's asset allocation, long term orientation, future expected performance of the fund (a basket of stocks underlying the CPSE ETF), and diversification potential of the underlying stocks in the ETF. Due to the above reasons, the FFO of CPSE ETF may not be suitable to most of the investors.

As buying the underlying stocks by large institutional investors involves high impact cost, such large investors, like, EPFO, LIC of India and other insurers may be tempted to invest in this ETF.

The managers to the offer are marketing the FFO of the CPSE exchange traded fund with the following reasons: there is a 5% discount to investors; the ETF is eligible for Rajiv Gandhi Equity Savings Scheme; invests in ten so-called "Maharatna" and "Navratna" companies; the ETF is outperforming Nifty 50 index; low expense ratio of 0.065%; and 4% dividend yield of the CPSE Index.

All these reasons do not outweigh the risks involved in the CPSE ETF, like, high concentration risk, perceived mismanagement and unnecessary interference by the government and high exposure to natural resources stocks.

If one is positive about the future performance of the underlying stocks, one might take a small exposure to the further fund offer of the CPSE ETF. Before you take a decision on investing, you better read the following web links:

Read More:

Analysis of New Fund Offer of CPSE ETF dt 19Mar2014

Reliance MF product features of FFO of CPSE ETF dt 9Jan2017

Supplement to SID of CPSE ETF dt 9Jan2017

ICICI Direct.com Salient Features of FFO of CPSE ETF dt 11Jan2017

CAG Report of CPSEs for FY 2014-15 dt 09May2016

Abbreviations:

EPFO - Employees Provident Fund Organisation

BSE - Bombay Stock Exchange

NSE - National Stock Exchange

Disclosure: Don’t own any units in the above ETF. But I own a few shares in a few PSUs.

Disclaimer: The brief analysis provided here 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 a CFA Charterholder with a vested interest in financial markets. He blogs at:

http://ramakrishnavadlamudi.blogspot.in/ 

http://scribd.com/vrk100