PSU ETFs: Why would you want to own a basket of govt-owned stocks?

I received a call from my friend asking me what I thought about the exchange-traded fund (ETF) of selectcentral public sector enterprisesthat opened for subscription today , 18, March 2014. (The CPSE ETF is an open-ended scheme that consists ofshares of 10 major public sector units, including Oil &Natural Gas Corporation, GAIL India and Coal India.)My answer was a question " Do you want to own a basket of stocks of Government owned companies?". His immediate answer was a big No. He did not even have to think about the “No” answer as the perception of anything owned and run by the Government is negative at this point of time.

To put it in numbers, the BSE Sensex has returned 127% over the last five years (March 2009 to March 2014) while the BSE PSU Index has returned just 20% in the same period, a relative underperformace of a whopping 107%.

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The Government is an inefficient manager, not only of its own finances that are in a huge mess but of the enterprises it owns.

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The Government also uses its enterprises to satisfy its political needs. The biggest case in point is the milking of ONGC to pay for its fuel subsidies and the raw deal that it gives the OMCs (Oil Marketing Companies) to pay for its subsidies. ONGC’s subsidy burden is set to cross Rs 500 billion (Rs 50,000 crore) in FY 2014, the highest on record. Refiners such as IOC, BPCL and HPCL are constantly running at losses as the government does not pay them the subsidy amount on time and this leads to higher borrowings, higher interest costs, lack of funds for modernization and expansion and loss in employee morale.

The Government by nature cannot work like an efficient management and look to improve shareholder value. Labour productivity is low as the government cannot reward the best while it cannot punish the underperformers. The Government also believes that is cannot be fully profit oriented. It has to fulfill social obligations that sometimes takes precedence over shareholder value.

The list of cribs of a Government managed enterprise is endless. Hence owning a basket of stocks owned by the Government is a no-no. However, one should not completely shy away from Government owned companies, especially if there is enough value in some efficiently-run enterprises. At this juncture, given the beaten down prices of public sector stocks, there are a few companies that do offer value. Go for these few companies offering value rather than a basket of stocks of Government owned companies.

CPSE ETF

Government of India had estimated Rs 40,000 crore of revenues through disinvestment programme for fiscal year 2013-14. However, till February 2014 it had managed to disinvest only Rs 7478 crore. To give a boost to its disinvestment programme, the Government of India has launched a Central Public Sector Enterprise Exchange Traded Fund (“CPSE ETF”) constituting equity shares of Central Public Sector Enterprises, which is launched as a CPSE ETF Mutual Fund Scheme. The Department of Disinvestment appointed Goldman Sachs Asset Management (India) Private Limited to launch and manage the GS CPSE ETF in accordance with SEBI Regulations.

The government expects to raise Rs 3,000 crore from the CPSE ETF. The CPSE ETF will be a basket of 10 stocks. The Government is offering a five percent discount to investors who will apply in the New Fund Offer (NFO).CPSE Index is constructed in order to facilitate GOI’s initiative to dis-invest its stake in selected CPSEs. The GOI has opted for ETF route for disinvestment. The ETF shall track the performance of the CPSE Index. The index values would be calculated on free float market capitalization methodology. The CPSE Index has base date of 01-Jan-2009 and base value of 1000. Weights of index constituent shall be re-aligned (i.e. capped at 25%) every quarter effective 2nd Monday of February, May, August and November.Likely component of Index will be ONGC, GAIl, Coal India, REC, IOC, Oil India, Container Corp, PFC, BHEl and EIL( source: Business Standard).

Benefits of ETFs
It can be easily bought / sold like any other stock on the exchange through terminals spread across the country. It can be bought / sold anytime during market hours at prices that are expected to be close to actual net asset value of the scheme. Thus, an investor invests at real-time prices as opposed to end of day prices. It gives ability to put limit orders. It protects long-term investors from the inflows and outflows of short-term investors. It helps in increasing liquidity of underlying cash market. It aids low cost arbitrage between futures and cash market.During NFO period all investors will be allotted CPSE ETF units by Goldman Sachs AMC. Once scheme is listed on exchanges investors can trade units of CPSE ETF.

Arjun Parthasarathy is founder Investors are Idiots.com and INRBONDS.com. Follow him on twitter @arjunparthasara