Bharat-22 ETF could generate good returns

and SBI. The offering gave a 3 per cent discount to all investors on market price. The ETF is managed by ICICI Prudential. The scheme has a mechanism for rebalancing and profit booking.

The government will be happy since the ~14,500 crore it received will go towards the disinvestment target of ~72,500 crore for 2017-18. ETFs are among the best passive instruments in terms of structure. As of now, the PSU weight is about 62 per cent with the three non-PSU stocks, ITC, L&T and Axis Bank contributing about 38 per cent.

The rebalancing mechanism is interesting. This is like an index fund, the returns will mirror the returns from the given population of stocks at the given weight. The stocks will be weighted according to free float market capitalisation with a maximum weight cap per sector and per stock of 20 per cent and 15 per cent, respectively, and an annual rebalancing in March. The selection criteria includes a "dividend floor", the company should have paid dividend of not less than 4 per cent (calculated as yield on market price) including a bonus for the seven years immediately preceding, or for at least seven out of the nine preceding years.

Since the weight and dividend, etc, are public information, the investor (and traders tracking the ETF) will get clear, predictable buy/sell signals on stocks and sectors that have gone overweight or underweight. That could have an interesting impact in March since traders may be able to front-run.

Also, given high government holdings in PSUs, the private component will always have a relatively high weight due to the free float methodology. This is useful because the private companies are liable to outperform the PSUs most years.

ITC offers rock-solid noncyclical returns. Although tobacco is a "sinful" business with high taxes, it has a captive market and generates huge positive cash-flows. L&T is a large diversified engineering major with a pan-India presence and a finger in every major infrastructure initiative. Axis Bank has somewhat better financials than PSU banks although its balance sheet is nothing to write home about.

The average annualised returns delivered by Bharat 22 ETF across all 3-year holding periods since March 2006 is around 14.86 per cent, higher than the Nifty's 11.03 per cent. The Bharat 22 ETF has a higher dividend yield of 2 per cent during 2016-17 compared to 1.4 per cent for the Nifty. The worries are on account of the PSUs. PSUs tend to be under performers over the long-term. This is due to political interference and unwieldy internal governance structures. There is a knowledge versus power divide in PSUs. The management has plenty of expertise and knowledge. But, people who lack that knowledge have the power to make key decisions. The focus is not on delivering shareholder return.

Every so often, there is a burst of PSU buying as investors hope-against-hope for reforms. However, not much reform is likely over the next couple of years because of the scheduled elections. Despite that drag, the ETF could give good returns if the market sentiment remains strong.

The rebalancing mechanism is interesting. This is like an index fund, the returns will mirror the returns from the given population of stocks at the given weight