CPSE ETF FFO – An Energizing Offer – JainMatrix Investments

Date: 14th Jan 2017
FFO Application: 18-20th Jan and Listing by 10th Feb, 2017
Amount to be raised: maximum of Rs. 6,000 cr.
Managed by Reliance Nippon Life Asset Management
Central PSEs, Exchange Traded Fund, Further Fund Offer
Buy with a 1 year perspective.

Overview: The Scheme is a follow on issue after the 2014 offer which was quite successful. CPSE ETF facilitates GoI’s initiative to disinvest stake in CPSEs through the ETF route. Past performance of CPSE ETF 2014 has been good with 19.8% CAGR over 33 months. A discount of 5% on the “FFO Reference Market Price” of the underlying shares of Nifty CPSE Index shall be offered to FFO of the Scheme. There are high sectoral risks in Oil and Gas sector with a commodities play. Also typically the asset rich PSUs are slow moving firms with a poor, lethargic culture. However overall the offer is attractive and rated a BUY with a 1 year perspective.

Advice: This is a medium risk, medium return offering suitable for conservative investors. Buy with a 1 year perspective.

Here is a note on the CPSE ETF Offer 2017.

Offer Description

The Scheme is an open-ended index scheme, listed on the Exchanges in the form of an Exchange Traded Fund (ETF). The investment objective of the Scheme is to provide returns that closely correspond to the returns of the Nifty CPSE Index, by investing in the constituents of the Index in the same proportion as in the index.
The CPSE ETF 2017 is an instrument created to help the GoI in the disinvestment of PSUs. Post listing, there is a facility that further disinvestment can also be done through this vehicle.
Ten leading PSUs’ will be included in this ETF. Typically these are fairly well known high dividend, low capital gains but asset rich companies.
FFO Price: The FFO Units being offered will have a face value of Rs. 10/- each and will be issued at a premium equivalent to the difference between FFO Allotment Price and the face value of Rs. 10/- each. The FFO Allotment Price would be approximately equal to 1/100^th of Nifty CPSE Index and would be calculated considering discount offered by GOI pursuant to FFO of the Scheme for buying underlying Nifty CPSE Index shares out of the FFO Proceeds.
Discount: A discount of 5 % on the FFO Reference Market Price of the underlying shares of Nifty CPSE Index shall be offered to FFO of the Scheme by GOI.
Retail gets at least 70% quota of entire Offer. Anchor investors + QIB + NII will get the remaining available 30% quota of offer.
The scheme is being managed by Reliance Nippon Life Asset Management Limited (RNLAM)

Investment Details of the Scheme

The Scheme will invest at least 95% of its total assets in the stocks of the Nifty CPSE Index.
The Scheme may invest in Money Market Instruments upto a max of 5% of its assets which could include T-Bills, commercial paper of public private sector corporate entities, etc.
Amount to be raised: Rs. 6,000 cr. includes Initial Amount of Rs. 4,500 cr. and Addl. Rs. 1,500 cr.
The AMC will use a passive or indexing approach to try and achieve Scheme’s investment objective. Unlike other Funds, the Scheme does not try to beat the markets they track and do not seek temporary defensive positions when markets decline or appear overvalued.
Sectoral asset Allocation and historic returns – Source: Reliance MF FFO document

Table 1 – Sector allocation/ Table 2 – CPSE ETF 2014 returns inc. Dividend

Portfolio Turnover: With Subscriptions and Redemptions on a daily basis and tracking error, Portfolio Turnover Ratio is expected to be 0.15 as on Dec 31, 2016.
Dividend: The income received by way of Dividend shall be used for recurring expenses and redemption requirements or shall be accumulated and invested as per the investment objective of the Scheme. The Trustees may declare Dividend to the Unit holders under the Scheme subject to the availability of surplus, and at the discretion of the Trustees. If the Fund declares Dividend, the NAV of the Scheme will stand reduced by that amount.
Listing: The units of the Scheme will be listed on NSE and BSE by maximum Feb 10, 2017.
RGESS Eligibility: Investments made by a Retail Investors in the RGESS Scheme will qualify for a 50% deduction of the amount invested from the taxable income of the financial year.
Analysis of the ten PSUs as part of this ETF

Table 3 – CPSE ETF FFO PSUs analysis

Note 1: The Engineers India Ltd recent report by JainMatrix Investments is available on LINK
Note 2: When we say price is high, it is relative to 5 year historical prices. We have not done valuation exercises on these firms.

The ETF structure is explained below.

Table 4 – Nature of ETFs; Source: Reliance Mutual Fund FFO document

Past Performance

The CPSE ETF 2014 was listed in April 2014, and has been able to give original NFO investors an absolute 64.24% returns over 33 months. This includes a 1 year bonus for Retail, which is not available in CPSE ETF 2017. The returns for Retail are 19.77% CAGR, higher than those in Table 2 published in FFO. Also see reports made by JainMatrix:

JM March 2014 report – CPSE ETF 2014 – New Fund Offer
JM Sept2015 performance review – Review Sept 2015 of CPSE ETF 2014

Table 5 – Past Performance of CPSE ETF 2014

PROS

This ETF offering has a lower management charge as stock selection and portfolio changes are automatic. The expense ratio is just 0.065% annualized.
The fund will offer 5% discount to the FFO subscribers.
The 5 year share returns are 8.05% CAGR, see Table 4. This is fair but below Sensex of 10.59%.
The dividend yield for these stocks is 5.24% today which is good, Table 4.
The average beta of these stocks is 1.16 indicating higher volatility than indices.
Many of these firms own wonderful assets, the family silver of the GoI. Some of these firms also enjoy monopoly status in their sectors. See our opinions in Table 4.
GoI is asking for higher dividends from PSUs and also allowing operational freedom to exploit assets and be more productive. This is positive. See report, A Repurpose for our PSUs
The crude oil price fell last year from USD 100+ levels to sub 50 per barrel. The fall looks complete for now. While prices are volatile, crude in next 1 year should be in USD 40-60 range. If it does, the Oil & Gas (O&G) sector overall can perform well.
This fund is O&G heavy with 57% weightage. However it does have a mix of upstream, mid and downstream O&G firms, which together can derisk the portfolio against commodity volatility.
Employees’ Provident Fund Organisation decides to invest Rs2,800 crore in CPSE ETF. This surely meas that the institutional quots will be over subscribed.

CONS

While the expense ratio of the ETF is low, the high dividend paid by the PSUs may not be passed on to the unit holders, but used for recurring expenses, as per FFO document. The CPSE ETF 2014 too has not paid dividend for 2.5 years. The 5.4% dividend yield this year involve substantial monies. It’s not clear if dividends have contributed to the NAV of the CPSE ETF 2014.
This fund is O&G heavy with 57% weightage. If one extends the description to Energy/Coal/ Power/ O&G and related financing, it increases to 90%. These sectors are essential to the economy, but are typically operationally constrained and not shareholder friendly. They are dependent upon global prices, and so even well managed firms can swing to losses with a fall in commodity prices. In O&G sector, the upstream Oil Exploration firms have been hit by falling crude oil prices.
Even though Gail India has a monopoly, it has been hit in pipeline construction by interstate politics, farmer /social pressures and weak infra execution environment.
These stocks performance depends on revenue growth, which has been inconsistent in recent years.
Many of these firms depend on GoI policies and monopoly situations to grow. Some are externally constrained by weak infrastructure that hampers distribution (Railways for coal, pipelines for gas).
PFC and REC are executors of GoI programs in power sector. Their returns are sometimes guaranteed by GoI but when the entire sector gets stressed, they can suffer poor performance.
This CPSE ETF 2017 offering is managed by Reliance Mutual Fund.

Overall Opinion

The current govt. is focusing on good execution and better administration with a series of reforms. The environment is more result oriented with less political interference in PSUs.
The outlook for Oil & Gas sector is stable this year. Domestic demand is high.
Past performance of CPSE ETF 2014 has been good with 19.8% CAGR over 33 months.
Retail gets at least 70% of CPSE ETF offer, so it is skewed in their favour.
There are high sectoral risks with a commodities play. Also typically the asset rich legacy PSUs are slow moving firms with a poor, lethargic culture.
However overall the offer is attractive and rated a BUY with a 1 year perspective.
This is a medium risk, medium return offering suitable for conservative investors.

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Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Punit Jain discloses an ownership in CPSE ETF 2014 units as a Retail application in NFO only. Other than this JM has no known financial interests in CPSE ETF / Reliance Mutual Fund or any related firm. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Punit Jain is a registered Research Analyst and compliant with SEBI (Research Analysts) Regulations, 2014. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com .