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Are your index, exchange-traded funds face concentration risk?

KS Badri Narayanan Chennai | Updated on January 18, 2019 Published on January 18, 2019

Nifty PSU Bank, Bank and Infra indices need to rejig the constituents

Aiming to mitigate portfolio concentration in index and exchange-traded funds, the Securities and Exchange Board of India last week tweaked their investment norms.

Accordingly, index funds/ETFs are now required to invest in an index that has a minimum of 10 stocks as its constituents. For a sectoral or thematic index (such as pharma, banking, consumption, services sector and MNC), no single stock should have more than 35 per cent weightage in the index. For non-thematic indices, no single stock should have more than 25 per cent weightage.

Besides, total weightage of the top three constituents of the index should not exceed 65 per cent. Further, individual constituents of the index should have a trading frequency greater than or equal to 80 per cent, and an average impact cost of 1 per cent or less over the previous six months.

The index fund issuer should ensure compliance with the new norms for all its ETFs and index funds at the end of every calendar quarter, SEBI said, and added that all the equity ETFs and index funds that have got final observations should submit the compliance status vis-à-vis these norms before launching their funds.

Currently, there are about 35 ETF or index funds-based NSE indices that include Nifty 50, Nifty Bank, Nifty Next 50, PSU Bank and CPSE ETF and about 10 funds on the BSE Sensex such as ICICI Prudential Sensex, Reliance Index Fund, HDFC Index Fund and Tata Index Fund-Sensex.

A close look at the portfolio and composition of these schemes indicate that almost all the schemes including CPSE (Central Public Sector Enterprises) ETF and Bharat 22 ETFs are already in line with SEBI norms.

Recalibration

However, schemes launched on Nifty PSU Bank, Nifty Bank and Nifty Infra will need to recalibrate, as the weightage of their top scrip is high. For instance, SBI dominates with 71.84 per cent weight in Nifty PSU Bank, while HDFC Bank (36.20 per cent) and L&T (36.38 per cent) have large weightages in the Nifty Bank and Nifty Infra indices, respectively.

Already, the assets under management of passively-managed index/ETF funds have crossed the ₹1-lakh-crore-mark, thanks to new launches in the last few years, continuous inflow from the Employees’ Provident Fund Organisation and systematic investments by retail and HNIs.

Currently, close to 100 ETF/index funds manage an AUM of ₹1.16 lakh crore, while in 2010 the total AUM was just ₹5,000 crore.

Currently, as financial planners are recommending index funds and ETFs over diversified large-, small- and mid-cap schemes due to volatility, the timing of the SEBI move is good. This will help retail investors, as they should not suffer due to sharp movements in a few stocks in the indices.

Published on January 18, 2019
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