Concentrated index makes CPSE ETF risky

Recent changes have not altered the heavy tilt towards energy and commodity sectors

In case of fixed-income products like Public Provident Fund, Senior Citizens Savings Scheme, and so on, a sovereign guarantee provides assurance to risk-averse investors. In the equity markets, however, government ownership is no guarantee of wealth creation for investors.

The sixth further fund offer (FFO) of the Central Public Sector Enterprise Exchange Traded Fund (CPSE ETF) opens to non-anchor investors on Friday (it will last just for a day). It is being offered at a 3 per cent discount to the reference market price. This price will be determined, based on the average of fullday, volume-weighted average price of each constituent of the Nifty CPSE Index on the National Stock Exchange during the non-anchor FFO period.

The ETF offers investors access to a basket of 12 quality CPSE stocks. Many of them are either sector leaders or near-monopolies in their segments.

Among the positives of the offer, the Nifty CPSE Index’s valuations are more reasonable than that of front line indices. It is trading at a price-to-earnings ratio of 8.71, whereas the Nifty50 is trading at 28.30, and the Nifty Next 50 at 68.86 (as on January 29, 2020). This ETF also has a negligible expense ratio of 0.0095 per cent.

Experts, however, have a few reservations about the offering. The first pertains to majority ownership by the government. “The government has not traditionally been a good allocator of capital. It has not demonstrated high skill in using the assets within a company to generate returns for shareholders,” says Ankur Kapur, managing partner, Plutus Capital.

Adds Rajesh Cheruvu, chief investment officer, Validus Wealth: “Public-sector enterprises have been facing a lot of challenges in business execution. Even the nearmonopoly situation in their segment for many has not translated into attractive profits and earnings growth.” The index underlying this ETF has only 12 stocks, which makes it highly concentrated. Furthermore, the top four holdings alone constitute 79.48 per cent of the portfolio. “Mutual fund and ETF investors desire diversification and stability, which they may not get here,” says Mumbai-based financial planner Arnav Pandya.

Many of the companies in this ETF are commodity-oriented. “Commodity companies tend to be highly cyclical. They are also low-return on investment businesses,” adds Kapur.

This ETF is also tilted heavily in favour of the energy sector. Power has a weight of 44.98 per cent, and oil, 22.2 per cent. The minerals and mining sector accounts for 25.18 per cent weight. Despite two stocks — Indian Oil Corporation and Power Finance Corporation — exiting the index, and four new ones — Power Grid Corporation of India, Cochin Shipyard, NHPC, and NMDC — being added, the essential nature of the index — concentrated and energy-/commodity-oriented — has not changed.

“Barring Powergrid, the other entrants have little weight to make much of an impact on the nature of the index,” says Pandya.

The ETF’S past performance also does not inspire confidence. Over a five-year period, it has underperformed front line indices like the Nifty and the Sensex.

The discount offered on successive FFOS has been coming down from the level of 5 per cent in the earliest offers to 3 per cent now. The lower discount rate makes taking a short-term bet on the FFO risky.

“It is not advisable to take shortterm bets in the current macroeconomic conditions, where downside risks in the market are high,” says Cheruvu.

Investors who want to invest in a large-cap ETF should go for one based on the Sensex or Nifty.