Commerce for IAS – WHY CPSE ETFs ARE MAKING HEADLINES?
Recent announcement of Further Fund Offer of CPSE ETF has created a sort of buzz in the market. Now, as the investors make their decision to become unitholder, we as students have to have a greater understanding of what are these. As far as UPSC Commerce Optional is concerned, they can be asked as Part of Indian Financial System (Paper 1).
First, the most important question – What are ETFs?
An ETF, or exchange traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund.
An ETF is a type of fund which owns the underlying assets (shares of stock, bonds, oil futures, gold bars, foreign currency, etc.) and divides ownership of those assets into shares. Shareholders do not directly own or have any direct claim to the underlying investments in the fund; rather they indirectly own these assets.
ETFs – A Better Version of Mutual Funds
Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors. Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated once at the end of every day like a mutual fund does.
Advantages of ETF:
ETFs provide exposure to an index or a basket of securities that trade on the exchange like a single stock. ETFs offer benefits of diversification, liquidity & convenience to customers. They offer a number of advantages over traditional open-ended index funds as follows:
- While redemptions of Index fund units takes place at a fixed NAV price (usually end of day), ETFs offer the convenience of intra-day purchase and sale on the Exchange, to take advantage of the prevailing price, which is close to the actual NAV of the scheme at any point in time.
- They provide investors a fund that closely tracks the performance of an index throughout the day with the ability to buy/sell at any time, whereby trading opportunities that arise during a day may be better utilized.
- They are low cost.
- Since an ETF is listed on an Exchange, costs of distribution are much lower and the reach is wider. These savings in cost are passed on to the investors in the form of lower costs. Further, the structure helps reduce collection, disbursement and other processing charges.
- ETFs protect long-term investors from inflows and outflows of short-term investors. This is because the fund does not incur extra transaction cost for buying/selling the index shares due to frequent subscriptions and redemptions.
- Tracking error, which is divergence between the NAV of the ETF and the underlying Index, is generally observed to be low as compared to a normal index fund due to lower expenses and the unique in-kind creation / redemption process.
- ETFs are highly flexible and can be used as a tool for gaining instant exposure to the equity markets.
What is CPSE ETF?
Now, we know that, an ETF is a mutual fund whose portfolio exactly duplicates an existing index. So, the CPSE ETF holds the same basket of stocks, in the same proportion as the Nifty CPSE Index. Its returns are expected to very closely mirror the performance of this index.
Ten central PSUs make up the portfolio of the Nifty CPSE ETF. Of these, ONGC, Coal India , IOC and GAIL take up the lion’s share.
CPSE ETF – A new tool to disinvest
When the Centre disinvests through the ETF route, a bunch of PSUs can be disinvested at one shot. The offer can be timed to good market conditions with a high decibel marketing campaign. This can help the government inch closer to its disinvestment target. A healthy mop up from disinvestment will mean lower burden on tax payers.
Benefits to investors
The CPSE ETF provides the investors the ability to participate in the long-term development of India, by purchasing stocks of blue chip PSUs. It provides small retail and High Net Worth investors the ability to diversify exposure across a number of Public Sector companies through a single instrument. They can be traded on stock exchange terminals across the country.