The government has announced the launch of its second exchange-traded fund (ETF), Bharat 22, which will comprise 22 government-run companies as well as a few of its holdings under the Specified Undertaking of Unit Trust of India (SUUTI).
Thanks to the positive response to its first ETF, it isn’t surprising that the government is increasingly using this route for disinvestment. The first central public sector enterprises or CPSE ETF, offered in 2014, had managed to outperform the Nifty 50 index by end-2016. In response, the government made two follow-on offerings of the CPSE ETF earlier this year and raised Rs8,500 crore in the process. The fact that the Employees’ Provident Fund Organisation (EPFO) participated in the follow-on offerings helped the government’s cause as well.
Interestingly, this (CPSE) ETF has underperformed the broad markets by 17.5% in the past three months. And based on a full market capitalization methodology, the Bharat 22 portfolio has also underperformed the broad market in the past five years (see chart).
However, the presence of stocks such as ITC Ltd and Larsen and Toubro Ltd in the proposed ETF should evince interest. According to a former fund manager, some large investors may well adopt a so-called ITC-stripping strategy using the ETF. For this, they could redeem their ETF holdings, receive the underlying shares, and sell all but their ITC holdings in the secondary market. The price risk associated with the other stocks can be hedged away in the futures and options markets, he adds.
But why adopt this roundabout strategy when ITC shares can be bought in the secondary markets anyway? For one, the impact cost of buying a large stake can be avoided; and secondly, since the government tends to sell these portfolios at a discount, the ETF route can be a cost-effective way of taking a position in the company.
In any case, given the rising markets and support from institutions such as EPFO, generating demand for the new ETF should not be an issue.