CPSE ETF FFO 2 – An Energizing Offer – BUY

FFO Applications: 15-17th Mar; Listing by 7th Apr
ETF has 10 PSUs; Oil and Gas heavy
Raising amount: Rs. 2,500 cr.
Managed by Reliance Nippon Life Asset Management
Central PSEs, Exchange Traded Fund, Further Fund Offer 2
Buy with a 1 year perspective

Overview: The Scheme is a further follow on issue (FFO 2) after the January 2017 offer which was 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 19.2% CAGR over 3 years. A discount of 3.5% on the “FFO Reference Market Price” of the Nifty CPSE Index shall be offered in this 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 FFO 2 offer 2017.

Offer Differences

This is a smaller offer, of Rs 2,500 crores compared to Rs 6,000 crores FFO earlier in Jan 2017
Very similar product, with CPSE ETF as benchmark
The retail discount on offer is 3.5% this time compared to 5% in the first FFO in Jan 2017
There is a small change in the allocation to the 10 companies of the Index, with PSU firms having more central govt. holdings getting a few % higher allocations.

Description

The Scheme is an open-ended index scheme, listed on the Exchanges in the form of an ETF. The investment objective is to provide returns like the Nifty CPSE Index.
In this offer 70% is reserved for Retail and QIB, while max 30% is for Anchor investors.
The CPSE ETF 2017 has been created to help in GoI disinvestment of PSUs. The Further Fund Offer (FFO) launched in Jan 2017 received good response; collections were Rs.13,742 cr., out of which Rs.7,742 cr. was refunded to investors due to limited issue size of Rs.6,000 cr.
The ten PSUs’ included in the ETF are known high dividend, low capital gains, asset rich firms.
FFO Price: The FFO Units being offered will have a face value of Rs. 10/- each and a premium equivalent to the difference between FFO Allotment Price and the FV . The FFO Allotment Price would be equal to 1/100^th of Nifty CPSE Index less discount.
Discount: A discount of 3.5 % on the FFO Reference Market Price of the underlying shares of Nifty CPSE Index shall be offered to FFO of the Scheme by GOI. A discount of 5% was offered to retail investors in the first FFO in Jan 2017 which has been reduced to 3.5% this time.
The scheme is being managed by Reliance Nippon Life Asset Management Ltd.

Investment Details of the Scheme

Amount to be raised: Rs. 2,500 cr. The Scheme will invest at least 95% of assets in stocks of the Nifty CPSE Index. It may invest in Money Market Instruments upto a max of 5% of assets which could include T-Bills, commercial paper of public private sector corporate entities, etc.
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:

Table 1 – Sector allocation Table 2 – CPSE ETF 2014 returns including Dividend

Source: Reliance Mutual Fund FFO 2 document

Analysis of the ten PSUs as part of this ETF:

Table 3 – CPSE ETF FFO PSUs analysis

Note 1: The Engineers India report by JainMatrix Investments is available on LINK
Note 2: The Bharat Electronics report by JainMatrix is available at LINK
Note 3: When we say price is high, it is relative to 5 year historical prices. We have not done valuation exercises on these firms.
Portfolio Turnover: It is expected that there would be a number of Subscriptions and Redemptions on a daily basis. Portfolio Turnover Ratio of the Scheme is 1.02 as on Feb 28, 2017.
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 April 7, 2017.
RGESS Eligibility: Investments made by a Retail Individual Investor in the RGESS Scheme will qualify for a 50% deduction of the actual amount invested from the taxable income of the financial year.

The ETF structure is explained below.

Table 4 – Nature of ETFs Source: Reliance Mutual Fund FFO 2 document

Past Performance since launch in March 2014

Table 5 – Performance of CPSE ETF since 2014 (as on 13^th Mar 2017)

The CPSE ETF 2014 was listed in April 2014, and has been able to give original NFO retail investors an absolute 69.4% returns over 36 months. This includes a 1 year bonus for Retail, which is not available in CPSE ETF 2017. The CAGR returns are 19.2%, higher than those in Table 2 published in FFO. See reports:

JM Investments Mar 2014 report – CPSE ETF 2014 – New Fund Offer report
JM Investments Sept 2015 performance review – Review Sept 2015 of CPSE ETF 2014
We had published a report on the FFO (Further Fund Offer) of CPSE ETF on 14^th Jan, 2017. And recommended a BUY with a 1 year perspective. You can have a look at the report on the following LINK and the video on this LINK.
Subscription response: The Reliance Mutual Fund managed CPSE ETF opened for applications from 17-20th It was subscribed by 2.30 times, with bids worth Rs13,802 cr. coming in against the issue size of Rs 6,000 cr. The FFO received 250,000 applications, with good demand across investor segments.
FFO Price: The FFO Allotment Price is approximately equal to 1/100^th of Nifty CPSE Index minus discount. The allotment price was Rs 25.21 and this tranche was listed on 31^st
Performance: The EOD closing price on the exchange was Rs. 27.71 today, i.e. 13^thMar, 2017. This translates into a gain of 9.9% in 1.5 months.

PROS

This ETF has a lower management charge as this automatic. The expense ratio is 0.065% annualized.
The fund will offer 3.5% discount to the FFO 2 subscribers.
The 5 year share returns are 7.47% CAGR, see Table 3. This is fair but below Sensex of 10.63%.
The dividend yield for these stocks is 5.18% today which is good, Table 3.
The average beta of these stocks is 1.15 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 3.
GoI is asking for higher dividends from PSUs and allowing operational freedom to exploit assets and be more productive. This will benefits investors also. See report, A Repurpose for our PSUs
The crude oil price fall from USD 100+ levels to sub 50 per barrel is complete. While it is volatile, crude in next 1 year should be in USD 40-60 range. If it does, the Oil & Gas sector can perform well.
This fund is Oil and Gas heavy with 57% weightage. However it does have a mix of upstream, mid and downstream O&G firms, which together can de-risk the portfolio against commodity volatility.

CONS

This third fund raising is an opportunistic attempt by GoI to raise funds in FY17 based on the good market conditions and the success of the Jan 2017 offer. However every successive offer dilutes incremental gains and novelty of the offer. This dilution is being run in parallel with stock level dilution efforts like the Offer for Sale (OFS) with Bharat Electronics and Engineers India.
There is no strategic clarity on GoI shareholding in these firms – will they be fully divested, or a strategic sale, or as JVs, or retained with GoI majority holding in the long run.
While the expense ratio of the ETF is low, the high dividend paid by the PSUs is not being 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 3 years. The 5.18% dividend yield involves 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/ Oil & Gas 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 Oil & Gas sector, the upstream Oil Exploration firms have been hit by falling crude oil prices. The CPSE ETF is upstream Oil & Gas heavy with ONGC having 25% weightage.
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.
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.
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).
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 19.2% CAGR over 3 years.
There are high sectoral risks with an Oil & Gas heavy 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.
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 holds CPSE ETF units since NFO in 2014. 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 .