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Interviews ‘Quant based ETFs can beat active funds’

‘Quant based ETFs can beat active funds’

Since ICICI Securities was the advisor to the government on CPSE ETF’s FFO, we caught up with Vineet Arora, Executive Vice President, ICICI Securities to understand his perspective on ETFs, what need to be done to popularize ETFs in India and why advisers should recommend CPSE ETFs to their clients.
Team Cafemutual Jan 18, 2017

ETFs have been around since 2011; however, this category is yet to witness acceptance among investors. What needs to be done to promote ETFs in India and why should investors look at ETFs?

It is important to first understand what ETFs are and how they are different from Mutual Funds. ETFs track a pre-determined index and the task of the AMC is to track the index efficiently, i.e. with minimal tracking error. Being largely passive in nature (though there are ETFs which are active, quant based etc.) they come at low cost. They also offer other advantages like real time NAV, Liquidity etc.

Globally, ETFs are a very large asset class with more than US$3 trillion of assets.  They are used by institutions as well as Individual investors to manage their portfolio mix. As ETFs are the lowest cost asset class, investors tend to maintain a large portion of their portfolio under ETFs. The returns are made from maintaining a proper sector and asset allocation rather than stock picking. This process itself makes it suitable for long term investors who prefer to maintain a less volatile and well- constructed portfolio.

In India, ETFs started with gold ETFs and then gradually other ETFs were launched creating a reasonable mix of options being available. However, the industry is still at a very nascent stage and more products in the ETF basket will help in giving options to clients and their advisors. Over the last year and a half, with retirement funds like EPFO investing in ETFs, the cost of ETFs has come down in the market. For e.g. TER of CPSE ETF is only 0.065% as against TERs of 1.75-2.25% in case of MFs. As advisors and clients focus more on building a long term portfolio across sectors and asset class at the least possible cost we will see ETFs pick up in India as well. There are examples of quant based ETFs giving returns equal to and even higher than active funds. The alpha is generated by following a discipline of investing and maintaining proper mix in the portfolio. The ETF AUM in India has grown from close to Rs. 13,000 crore in 2014 to Rs.30,000 crore.

In India, when most of the active funds outperform benchmark, why should advisers consider recommending passive funds like CPSE ETF?

CPSE ETF constitutes of 10 CPSE which were selected at the time of NFO launch bases the following filters

a.       They should be listed

b.       They should have a minimum free float of Rs. 1000 cr.

c.       They should have a dividend paying track record of 4% for the last 7 years.

As you can understand from the above filters that these are large, liquid and fundamentally profitable companies. This gives a distinct flavour of stability to this basket.

If we compare its inception returns with Nifty, this ETF has outperformed Nifty by 5.5% with a CAGR return of 14.4% for CPSE ETF vs 8.9% for Nifty.

We also looked at longer term returns by back testing the index and observed that the returns are very similar to Nifty; however, they come with much lower volatility. The reason is that this basket is a high dividend yield basket, 4% as compared with 1.35% of Nifty.

Hence, CPSE ETF makes a good fit in an investor’s portfolio and to further sweeten the deal at the time of FFO, the investor gets a 5% upfront discount which is given in the form of additional units.

It is also important to note that this time after the allocation to anchor investors (30% of the issue size), first preference will be given to retail investors and then retirement funds and the remaining will be for other investors. This is a big positive for retail investors as unlike IPOs etc. they do not have a quota but first preference which gives them the first right on the entire book after anchor investor.

Since this ETF comprises only 10 stocks, what do you think about this concentration risk that investors will have to bear? Also, around 70% of the CPSE ETF comprises of energy companies, which make it a risky bet for retail investors. Your comments?

The basket consist of oil, oil marketing, minerals and mining, finance, transportation and industrial goods. The oil and oil marketing companies are very different from what they were 3 years ago, with the price de regulation they have become profitable companies and do not carry the subsidy burden anymore.

Minerals and mining are cyclical and we have seen an uptrend recently in this sector due to the anticipation of better infrastructure growth in India as well as US. China growth is also showing an uptick which can add to this demand. Finance, transportation and industrial goods will benefit from lower interest rates, GST and general uptick in Indian economy. Hence, we feel though the basket is more sectoral, it seems to be well poised to capture the upside in the near to medium term. Also, the upfront discount of 5% and dividend yield of 4% provide a good cushion.

To what extent should an investor take exposure to this thematic ETF?

The CPSE ETF offers a fair bit of diversification within the PSU theme. The 10 stocks are from across different investment themes. Investors get to invest into ONGC, Coal India and Oil India, which are Energy stocks, IOC and GAIL which would be beneficiaries of oil sector reform, Container Corp, BEL, Engineers India which are into Infra & Engineering and PSU Financials, PFC and REC. I think this is a good opportunity for investors to add a flavor of diversified PSU stocks, having the potential to add alpha, to their portfolio.

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