The unique concept of having both active and passive features may help investors to earn higher returns for the same risk.
Exchange Traded Funds (ETF) in India have not taken off in a big way as many actively managed funds continue to give superior returns when compared with key indices.
ETFs as an investment class have only mopped 0.19 per cent of the latest assets under management despite being in existence for almost a decade now.
Given this back drop, Motilal Oswal Asset Management Company has launched MOSt Shares M50 ETF, an open-ended equity ETF which tracks its in-house MOSt 50 basket.
Objective: MOSt 50 basket was introduced with the idea of earning higher returns for risk equivalent to the Nifty basket. It is a fundamentally weighted index with constituents of Nifty index getting weights based on the fundamentals rather than weights based on the market capitalisation (followed by the Nifty basket).
The ETF seeks to earn superior returns by giving preference to companies with reasonable valuations and consistently good fundamentals within the Nifty basket.
The illustration of the index shows 13 percentage points higher returns on an annualised basis for a little over a three-year period for MOSt 50 basket.
However, Most 50 index basket has tracked the Nifty basket from April 2007 to the lows of March 2009. It is only from March 2009 that MOSt 50 index gained multiple times that of Nifty.
Strategy: The Motilal Oswal AMC has designed this proprietary basket, which attributes weights to companies depending on pre-defined metrics such as return on equity, net worth, retained earnings and price.
The financial measures are taken on a historic basis. Then an algorithm classifies stocks into one of the three categories: over-weight, under-weight or equal weight, depending on their financial performance and valuations.
This weight would be different from that of the Nifty basket. For instance, while the Nifty 50 index has 15.8 per cent weight on the oil sector, MOSt 50 has given only a 2.4 per cent weight to this segment. While the ETF is passively managed to the extent that tracks the stocks in the index, it will be dynamically re-balanced periodically, based on changing fundamentals and whenever the constituents of Nifty index are changed.
Review: The unique concept of having both active and passive features may help investors to earn returns higher (called alpha returns) than what is commensurate with the risk of the basket. In addition ETFs have a low-cost structure and don’t entail any exit load, as they are traded like any other stock on the bourses.
Risks: As the fund considers historic data for evaluating fundamentals, any new development may not be factored into the rebalancing right away and, often, the market’s response by way of , re-rating/de-rating happens very quickly.
For instance, oil price de-regulation would not tend to reflect in the performance of MOSt basket, as against the Nifty 50 basket, given the low weights in the former.
The active strategy to a set basket of stocks also poses certain other risks. At times, higher weight to stocks that are under-valued for long (on expectations of re-rating), may affect the performance of the ETF, when compared with the Nifty index.
Weights based on pre-defined rules, lack of human intervention inability to diversify outside of the Nifty universe to boost performance may also heighten risks.
Besides, the MOSt 50 index still has to hold all the Nifty stocks, irrespective of their valuations. The NFO closes on July 19.
