Mumbai: Returns from the National Stock Exchange’s (NSE) Central Public Sector Enterprises Exchange Traded Fund (CPSE ETF) fell steeply in the past year, even as the exchange’s benchmark Nifty index rose.

The reason: A sharp fall in some of the constituents of the Nifty CPSE index, which is dominated by energy and metal companies. The ETF closely tracks the performance of the Nifty CPSE index.

The Nifty CPSE index lost 10.2% in the one-year period ended 25 May, while the benchmark 30-share Nifty index gained 11.52%. In 2018, too, the Nifty CPSE index has fallen 13.35%, while the Nifty is marginally up 0.71%.

The Nifty CPSE index is concentrated on a few stocks and is not broad-based, and the underperformance of a few has dragged it down, analysts said. Dhaval Kapadia, director, portfolio specialist at Morningstar Investment Adviser said: “Over the past one year, five out of 10 stocks, with a combined weight of around 33%, have been consistently dragging the performance of the index. Underperformance of GAIL, over the past six months, has put additional pressure."

The Nifty CPSE index includes Oil and Natural Gas Corp. Ltd, GAIL India Ltd, Coal India Ltd, Indian Oil Corp. Ltd, Oil India Ltd, Power Finance Corp. Ltd, Rural Electrification Corp., Container Corp. of India Ltd, Engineers India Ltd and Bharat Electronics Ltd. Stocks of some these companies have fallen 10-44% in the one-year period. 

The index has highest weightage to energy (58.54%) followed by metals (18.04%), financial services (8.97%), services (6.94%), industrial manufacturing (5.17%) and construction (2.34%).

“As Nifty CPSE index is highly skewed, weak performance of a few stocks has dragged the index, whereas Nifty index is more diversified and its top performers in the year are from sectors, including IT, FMCG and auto," said Vidya Bala, head, mutual fund research at FundsIndia.

“However, these funds may not show strong returns but are way better in dividend yields, which makes CPSE ETFs attractive. As on 30 April, dividend yield of Nifty CPSE is 4.5% whereas it is 1.2% for Nifty and this trend is expected to stay," Bala added. Dividend yield measures the quantum of cash dividends paid to shareholders as relative to the market value per share. It is a measure of an investment’s productivity and a sign of stability of a company. 

Valuation-wise, one-year forward price to earnings of Nifty CPSE index is 8.73 while that of Nifty is 17.91.

“The CPSE ETF offers attractive valuations compared with other major indices and can work well to create wealth in the long run. The investor should also understand the risks associated with such thematic funds like the concentration risk as the top four stocks constitute close to 70% of the portfolio. The portfolio is also likely to experience short-term volatility as and when the government makes policy changes," said research firm ICRA Online Ltd in a report.

Nifty CPSE index was created in May 2014 to facilitate the government’s disinvestment in select CPSEs through the ETF route. This was followed by launch of Bharat 22 ETF in November 2017, through which government divested its stake in 22 firms.

The government aims to garner Rs80,000 crore from divestments in 2018-19, with an aim to launch more ETFs. The government has also started the process of divestment in 24 CPSEs.

According to Bala, the upcoming ETFs will be more attractive if the composition is more broad-based and has a good mix to beat volatility and become more diversified.

“In India, active funds have historically generated sizeable alpha over respective benchmarks. But over recent years, the growing size of the mutual fund and insurance assets besides FPIs has resulted in a reduction in the alpha (or additional return over benchmark indices), particularly in the large cap space," Morningstar’s Kapadia said.

According to an analysis conducted by Morningstar, the percentage of large cap funds outperforming their benchmarks has come down from around 80% to 90% in 2016-17 to around 40% as on March 2018 (based on three-year rolling returns).

“If this trend continues, investor flows could start moving towards ETFs at least in the large cap space over the next couple of years. EPFO has already been investing in ETFs over the last couple of years," Kapadia said.

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