Why investing in public sector ETFs is a bad idea

As the end of the fiscal year draws near, the Government appears to be getting extremely nervous about meeting its disinvestment target of ₹40,000 crore.

A dull stock market and investors losing interest in stocks of public sector enterprises has resulted in the disinvestment programme raising just ₹1,325 crore so far this fiscal year. The desperation is evident in the unusual ideas being mooted, such as making Coal India pay a special dividend, asking ONGC and Oil India to buy stakes in Indian Oil and so on.

Another such idea to help raise the necessary money through disinvestment, but without having to bear the ignominy of the offer devolving, is by floating Exchange Traded Funds investing in public sector undertakings. This is a neat solution from the government’s perspective.

The mutual fund that will float this ETF will buy the stocks that are to be part of the ETF, such as Coal India, ONGC, GAIL, Power Grid and so on, from the Government and then offer them to the public as a basket of PSU shares. The Government will be able to raise the targeted ₹3,000 crore with minimum fuss.

While the Finance Ministry can pat itself on the back for the idea to raise money easily from the public sector companies, investors need to be circumspect when it comes to these instruments.

It is not clear on what basis the stocks forming the portfolio and their weights have been selected. The Government has been conscientious enough to include profit-making PSUs in the portfolio.

But it is obvious that the choice is also dictated by the companies in which the government wants to reduce stake.

PSU banks, for instance, are not part of the ETF portfolio. The presence of energy giants such as Coal India, Oil India and the oil marketing companies in the ETF pegs up the risks.

There is the question whether investors need to consider investing in PSU stocks at all, given the policy-related quagmire most of these are stuck in.

The CNX PSE index has under-performed the Nifty over the last three years due to these regulatory controversies.

There is also no clarity on whether the portfolio composition and weights will alter over time along with the performance of the companies and stocks. Since the ETF is not based on any exchange-promoted index, it will not be subject to periodic review either.

Exchange-traded funds have not really clicked with Indian investors in a big way. While these funds are intended to provide ample liquidity to investors and be freely traded like stocks, there is very little liquidity in ETFs on Indian exchanges.

The NSE trades less than ₹50 crore of ETFs everyday, with more than 95 per cent of the turnover emerging from bank and gold ETFs. Low liquidity in these instruments also results in their trading below net asset values. Again, purchasing ETFs entails exchange transaction costs, including brokerage.

Given these drawbacks, investors would be better off taking exposure to a basket of public sector enterprises through the actively managed mutual fund route.

The fund managers will ensure that the portfolio includes only the more profitable companies and lower exposure in the laggards.

Most of these PSU funds, too, have underperformed the benchmarks in recent times, but when the tide turns for these companies, a PSU fund might be a better way to include public sector companies in your portfolio.