April 29, 2018

More Questions About ICICI Prudential’s Bharat 22 Investments

As a follow-up to my last post, in this post I take a closer look at the investments in Bharat 22 ETF made by schemes of ICICI Prudential MF (I-Pru) and voice the questions that puzzle me.

At the start, let me confess that I don’t understand why any institutional investor, particularly a mutual fund, would want to buy units of Bharat 22 ETF.  It isn’t just because this is an ETF.  A lot of my confusion stems from the makeup of the index that the ETF tracks: S&P BSE Bharat 22.  It has a queer mix of large-cap and mid-cap stocks, and of PSUs and private sector enterprises.  The only common thread across the underlying stocks is that the government holds shares of each company.  It is perhaps a reflection of its oddness that the BSE and Asia Index (BSE’s JV with S&P DJI) have different views on its classification.  While the former categorizes it as a broad market index, the latter lists it as a thematic index.  Regardless, I can’t see the point of investing in such a motley collection of stocks together. 

So when I read that the Bharat 22 ETF NFO had received “the highest subscription in the history of Indian mutual fund industry”, I assumed that it had a lot to do with the persuasive marketing tactics of I-Pru, which manages that ETF.  It turned out to be more than just that.  It came to light that I-Pru had significantly contributed to the sales numbers by making large investments in this ETF through its schemes.  As on 30 Nov 2017, the first month-end portfolio disclosure after the completion of the NFO showed that 35 schemes of I-Pru, put together, held 68.2 crore units of Bharat 22 ETF that were valued at 2,533 crore.  This included schemes as diverse as Value Discovery Fund, Balanced Fund, Balanced Advantage Fund, Child Care Plan, Indo Asia Equity Fund, Top 100 Fund, Dynamic Plan, the Growth Fund series and the Value Fund series.  All the schemes put together accounted for over 21% of the AUM of the ETF.

So what was it about Bharat 22 ETF that the fund house found so appealing?  After all, unlike retail investors, the fund managers at I-Pru could easily analyze and buy individual stocks instead of buying the whole index.  The question becomes all the more relevant because, going by the previous month-end portfolio disclosures, the fund house already had investments in 19 of the underlying stocks that were collectively worth 25,314 crore. 

It seems that some of it had to do with the discount that was available to those who applied in the NFO.  At least that is what sources within the fund house have told me, and what I can gather from those who have spoken to people at the fund house.  Formally, though, it appears that the fund house prefers to give a more convoluted explanation.  To quote from an email exchange that one reader had with the fund house:

Schemes of ICICI Prudential Mutual Fund would invest in Exchange Traded Fund (ETFs) when it finds an opportunity available at a discount or on account of directional view on the market or as a tactical allocation to enhance portfolio returns.”

To me, most of that statement is mindless jargon.  But if the bit about the discount is true, and that is what prompted the fund house to invest in this ETF, it throws up several other questions. 

Should a fund house buy a security or a set of securities, just because they are available at a discount? Shouldn’t the investment be suitable in light of a scheme’s investment objective?  If so, what should one make of the fact that this investment was made across 35 different schemes of I-Pru?  Were all these stocks suitable enough to be held in all these schemes?

There is one other aspect of this affair that I find disturbing.  It relates to a statement released at the time of the NFO in which the CEO of the fund house was quoted as saying (emphasis mine):

“We believe the ETF offers an attractive long term investment opportunity to partake in the India growth story by way of a diversified blend of companies spread across several sectors and are available at attractive valuation and a good subscription discount.”

What bothers me is that, while I-Pru marketed this as “an attractive long term investment opportunity”, in its own schemes, it did exactly the opposite.  By 31 Jan 2018, barely two months since the launch of the issue, I-Pru had sold off its investments in 20 of those 35 schemes, and reduced its holding in 4 other schemes.  Is this what it meant by “long term” investing?  Or was it simply cashing in the discount that it had got? 

But that’s not all.  Alongside this, there is also the inexplicable swing in the number of Bharat 22 ETF units held by ICICI Prudential Balanced Fund (soon to be renamed as ICICI Prudential Equity & Debt Fund).

On 30 Nov 2017, this scheme held 21.9 crore units of Bharat 22 ETF.  By 28 Feb 2018, this number was down to 12.9 crore units.  But then, over the course of March 2018, the number of units held by the scheme jumped up to 17.4 crore units and as on 31 March 2018 these were valued at 609 crore, making it one of the scheme’s top 10 holdings.  Furthermore, as on that date, Balanced Fund alone held over 10% of AUM of Bharat 22 ETF.  What makes that all the more questionable is that, as I mentioned in the last post, this scheme already held 15 of those 22 stocks, and in such significant quantity that they accounted for over 25% of the scheme’s AUM.

So what was the need to increase this scheme’s exposure to Bharat 22 ETF in such a big way?  What was the need to do so in this scheme alone?

As I see it, the actions of I-Pru related to its investments in Bharat 22 ETF do not inspire confidence and, in my opinion, are not becoming of a responsible fund house.

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