In 2017, continuing with its divestment programme, the Department of Investment and Public Asset Management, Ministry of Finance, appointed ICICI Prudential Asset Management Co. Ltd as the fund manager for an exchange traded fund (ETF) that would hold shares divested from selected companies. The Bharat 22 ETF got its own benchmark, S&P BSE Bharat 22 Index, and was designed as a portfolio of shares of 22 public and private sector companies from which the government was selling some of its stake. The new fund offer in November 2017 was a success and an allotment of 14,500 crore was made to investors against an initial issue size of 8,000 crore. The fund currently has assets under management of 5,500 crore (31 May 2018), which suggests that its initial popularity waned with some investors redeeming within six months.

A follow-on fund offer for the ETF has been launched to divest another 6,000 crore in these companies.

What is it?

The follow-on fund offer for Bharat 22 ETF is another window to buy into these select 22 companies at a discount to the market price. Investors will buy into the ETF, constructed by buying shares of the companies at a 2.5% discount on the weighted average market price of these shares seen across three specific trading days (20, 21 and 22 June 2018). The money from the investors will go to the government, which will in turn pass on shares of these companies to the existing ETF.

There won’t be a new fund; the existing ETF will absorb the additional shares and investors (fresh units get created). In the meantime, the ETF will continue to trade on exchanges. This means you will get to buy into an existing product at a discount to the current market price.

What’s good ...

The discount is an advantage. The product is not new so reference for performance is available. The AMC has simultaneously launched a new fund offer for a scheme structured as a fund of funds (FoF), which will invest at least 95% of its assets only in Bharat 22 ETF. This makes the ETF accessible to investors who do not have a demat account. The FoF’s expense ratio will be the same as the Bharat 22 ETF and the discount will be passed on to these investors as well.

The underlying stocks are all large-cap companies that are well established in their sectors. At 22 stocks, the ETF is not too diversified compared to other large-cap funds, but is sufficiently so to reflect trends across the six sectors.

Over the last six months, the performance of the Bharat 22 ETF at -6.5% as against 4.5% from the S&P BSE Sensex for the same period  doesn’t inspire confidence.

However, the asset manager believes this under-performance presents good value for long-term investors.

According to S. Naren, executive director and chief investment officer, ICICI Prudential AMC: “Segments like corporate banks and oil and gas companies have corrected. We see an opportunity for performance turnaround in the next 2-3 years. Construction companies in the portfolio are also well placed to improve earnings. The ETF’s underlying constituents make for an attractive investment opportunity due to lower P-E , relatively better earnings growth and dividend yield in comparison to Nifty 50 and S&P BSE Sensex."

...What’s not

The fund has underperformed in comparison with other large-cap diversified funds. As its benchmark was created to facilitate the ETF itself, it isn’t the most accurate performance measurement standard. Performance against large-cap benchmarks lags with S&P BSE Sensex returning 4.5% in the last six months, Nifty 50 returning around 2.5% and the fund returning -6.5%. Performance has also lagged against that of equity diversified large-cap funds (see graph).

Six months is not a long enough history for comparison; you have to evaluate the opportunity cost of investing in an underperforming portfolio.

Does the fund add value to your portfolio and what is the opportunity that you leave to pick this? “To begin with we are not bullish on the underlying portfolio. Moreover, the primary motive is disinvestment rather than picking stocks based on investment merit. Lastly, this is not an actively managed fund, so there is unlikely to be an exit even if earnings growth turns sour for any of the companies. Why should (retail) investors be saddled with something so restrictive?" said Prateek Pant, head-products and solutions, Sanctum Wealth Management.

The 2.5% discount by itself is not reason enough to invest.

“For long-term investors, the discount of 2.5% is not a substantial contributor to annualised returns over, say, a 5-year period. There is lot of volatility in markets and benchmark indices can move 1% daily—the discount could evaporate in a matter of days," said Amol Joshi, founder, PlanRupee Investment Services.

There are other large-cap diversified funds with consistent performance track records overshadowing the benefit of this discount. Retail investors should stay away.

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What is a follow-on fund offer

A follow-on fund offer is a subsequent offer to an existing fund. These are not common for open-ended equity schemes as new inflows are a regular feature and get invested in listed shares. But in cases such as Bharat 22 ETF, the concept is different. More shares are added to the ETF basket. New units are created and allotted. The money raised is used to buy additional shares which get added to the portfolio. In this case, the government wants to offload additional shares in the companies that form part of Bharat 22 ETF. In an equity share follow-on offer, new shares dilute the capital base, and existing shareholders lose out. In an ETF follow-on offer, impact on existing investors depends on the price at which the additional shares get added.

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