Should you invest in the CPSE ETF?

Usually, investors would not rush to buy a basket of stocks that someone else is keen to sell. Technically, the CPSE ETF (Central Public Sector Enterprises Exchange Traded Fund) fits this description, as it is a fund designed to invest in public sector companies that the Centre is planning to divest.

But there are mitigating circumstances. The majority owner — the Government — is not divesting its stakes in PSEs because of poor business prospects. It is doing so to reduce its role in these businesses and to raise funds for the exchequer. Therefore, investors should make their decision on this fund based purely on its investment prospects.

The CPSE ETF managed by Goldman Sachs Asset Management will mirror the returns of the CPSE index from the National Stock Exchange. It will do this by holding exactly the same stocks that make up the index, in the same proportions. The ETF during its initial offer will collect money from investors and pass it on to the Government. The Centre will then deposit shares of equal value from the PSEs in the ETF. The CPSE index today has ten stocks, chosen on three criteria — a 55 per cent Government holding, a 4 per cent dividend yield, seven-year dividend paying record and a free float market cap of ₹1,000 crore or more.

Attractive valuations: PSE stocks offer good value even after the recent rally in the indices. The Nifty is at a new high, and its constituents trade at a price-earnings (PE) multiple of 18.3 times their trailing earnings today. But PSEs, which hail mostly from policy-heavy sectors, are inexpensive. The CPSE index has a modest PE multiple of 10.5 times earnings, at a steep discount to the Nifty.

Companies making up this fund have been selected for their dividend record in the last seven years; therefore, the fund is likely to receive steady cash flows from its holdings in the form of dividends. This will prop up its returns. The average dividend paid by companies making up the CPSE index is 3.5 per cent (of their market price). That is more than twice the market’s dividend yield of 1.4 per cent.

Low costs: The CPSE ETF plans to charge an annual fee of no more than 0.49 per cent of assets. Though there are actively managed funds from other fund houses that invest in the PSE theme, these charge expense ratios of 2.5 per cent or more of the assets managed. The difference in expense ratio can translate into an additional annual return of up to 2 per cent. At a discount: As a sweetener during the initial offer period, the ETF will get shares of the CPSEs at a 5 per cent discount to their market price. Investors who buy units until this Friday will also get additional loyalty bonus units. Those who hold the units for one year from allotment will be credited with one free ‘bonus’ unit for every 15 units held.

Cyclicals-heavy: The CPSE index is made up of stocks that the Government wants to divest. That tends to restrict stock choices. For instance, though the index has stayed away from troubled PSU banks or oil marketing companies, it doesn’t feature attractive PSEs such as PowerGrid or NMDC. It is heavily weighted towards energy stocks (59 per cent of the portfolio), metals (17 per cent) and finance (13.5 per cent).

The top stock ONGC has a heavy 26 per cent weight in the portfolio. With no representation from defensives and a portfolio heavily tilted towards policy-heavy, cyclical stocks, stocks in the ETF are inexpensive, but can prove quite volatile and vulnerable to economic cycles.

No active management: An ETF passively tracks an index and its performance depends entirely on the index. Therefore, if the companies making up this ETF flag on financial or stock price performance, the fund cannot get rid of them. In contrast, there are actively managed PSU funds such as the Religare Invesco PSU Fund, Sundaram PSU Opportunities, SBI PSU and Baroda Pioneer Opportunities. Their fund managers will select the best PSU stocks and keep changing the portfolio with shifting prospects.

Investing in PSE stocks is a good idea today, as they are available at a bargain. The CPSE ETF is the low-cost route to do this. But invest in the ETF only if you can actively track returns and book profits when the stocks run up.