SBI ETF – Quality: A NFO that you can consider

SBI Mutual Fund has announced the launch of its Exchange Traded Fund based on one of the NSE Strategic Indices.  SBI ETF – Quality would track the NSE 2011 Quality 30 index. The NFO is open between Nov 26 and Nov 30, 2018. In this short article, we look at the unique features of this index and ask if an investor should consider the ETF.

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What is an Exchange Traded Fund?

An Exchange Traded Fund (ETF) is a mutual fund scheme that is listed and traded on stock exchanges, quite like stocks.  And like stocks, the price is quoted through the trading day and could vary. Like mutual fund, the Net Asset Value (NAV) is made of up of its holdings in stocks and other securities. Most ETFs track an underlying index. SBI ETF – Quality would be the 40th domestic ETF in India. (More here) Being a passive investment, the parameters of an ETF are mostly derived from those of the underlying index. We would first look at this index.

NIFTY200 Quality 30 Index

NIFTY200 Quality 30 Index  (N200Q30) is a Strategic Index.

Strategy indices are designed on the basis of quantitative models / investment strategies to provide a single value for the aggregate performance of a number of companies.

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We have a good number of interesting, and useful, strategic indices in India. Some are equal weight versions of regular indices. some select a subset of broader stocks based on specific parameters, etc.  NIFTY200 Quality 30 Index is a relatively new index that selects 30 ‘Quality’ stocks from Nifty200 – the top 200 stocks by market capitalization. This covers all the large cap stocks and the 100 biggest mid cap stocks.


NIFTY200 Quality 30 includes top 30 companies from its parent NIFTY 200, selected based on their quality scores. The quality score for each company is determined based on return on equity (ROE), financial leverage (Debt/Equity Ratio) and earning (EPS) growth variability; analysed during the previous 5 years.

Highlights:

  • The index series has a base date of April 01, 2005 and a base value of 1000
  • Stocks from NIFTY 200 index at the time of review are eligible for inclusion in the index
  • 30 companies with higher profitability, lower leverage and more stable earnings are selected to be part of the index
  • The weight of each stock in the index is based on the combination of stock?s quality score and its free float market capitalization.
  • Index is rebalanced semi-annually
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Quality leads to superior risk adjusted returns

Though the index is new, the values have been back computed from Apr 1 2005. A whitepaper by IISL provides a good comparison of this index with NIFTY50 and NIFTY200. (See here.)

An interesting feature of such indices is that they combine rule based framework of passive investment with stock-specific factors used in active investment. If the factors consider the quality of the stocks, then you would expect that index to have better overall performance than the underlying broader index. And this is definitely the case with N200Q30.  The table below gives the annual returns of a few indices.


Year
NIFTY200 Quality 30 NIFTY 200 NIFTY 50
2005 38.29% 35.58% 37.19%
2006 29.43% 34.64% 39.83%
2007 48.23% 63.66% 54.77%
2008 -50.82% -56.61% -51.79%
2009 127.16% 86.58% 75.76%
2010 26.26% 14.20% 17.95%
2011 -11.54% -26.97% -24.62%
2012 28.93% 31.64% 27.70%
2013 17.47% 4.44% 6.76%
2014 38.12% 35.53% 31.39%
2015 0.88% -1.90% -4.06%
2016 -0.57% 3.70% 3.01%
2017 27.80% 33.43% 28.65%
2018 YTD -1.20% -5.41% -3.96%
  2018 data as of Mar 26 Courtesy IISL  

On calendar year basis, N200Q50 has outperformed NIFTY200 in 9 of 14 years, and NIFTY50 in 10 out of 14 years. More significantly, the drawdowns have been smaller N200Q50. Overall, the outperformance during bear phases has added to overall outperformance of this index. The whitepaper from IISL has detailed information on the drawdown in various years.

More importantly, the volatility of this index has been lower than the broader indices. The return-risk ratio has been much better.

  CAGR (%) Volatility (%) Return- Risk ratio
Period NIFTY200 Quality 30 NIFTY 200 NIFTY200 Quality 30 NIFTY 200 NIFTY200 Quality 30 NIFTY 200
Since inception 18.20% 12.88% 19.4% 22.4% 0.94 0.58
10 years 15.28% 8.44% 17.4% 21.0% 0.88 0.40
7 years 14.09% 9.26% 12.6% 15.3% 1.12 0.60
5years 16.03% 14.03% 12.6% 14.7% 1.27 0.95
3 years 6.25% 7.64% 12.2% 13.9% 0.51 0.55
1 year 15.71% 10.97% 9.3% 10.4% 1.69 1

Expectations from the ETF

Unlike the broader indices, there are few ETFs tracking strategic indices. The older NIFTY100 Quality 30 index has one ETF tracking it – Edelweiss Nifty 100 Quality30 ETF. It has an AUM of 5 crores and shows reasonable deviations between NAV and price. This deviation can pose issues when you transact. Unlike mutual funds where the AMC is the other party to any transaction, ETFs are traded among investors. Low AUM and thin volumes could pose a risk when you want to sell the ETF.

SBI Mutual Fund has a handful of other ETFs – they show a decent convergence between NAV and price. One can expect the new fund to have a decent AUM size. If it does, this would be a very good ETF in any equity portfolio.

Should you invest in SBI ETF – Quality NFO?

This would be the first ETF that tracks the NIFTY200 Quality 30 index, and the second ETF to track any of the Quality indices. The underlying index is composed of 30 Quality stocks selected based on High ROE, Low debt-to-equity ratio and Low EPS growth volatility. Compared to purely passive ETFs based on broader indices, this index provides an amount of active selection. If you are considering an index fund or ETF tracking NIFTY 50, NIFTY Next 50, etc. you may find this ETF a better choice to provide superior risk-adjusted returns.

Criticisms? Questions? Suggestions?  – Please leave a comment in the box below.

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