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Will index funds behave themselves?

Index funds are supposed to mimic the returns of underlying indices. But either they trail the indices widely or try to outdo the indices through active management. SEBI seems to be taking a hard look at them

The mutual fund industry seems to be waking up to the virtues of index investing. IDFC Mutual Fund is launching one and IDBI Mutual Fund is launching another. But index funds have not covered themselves with glory so far. Not only do index funds do not accurately track the movements of their underlying benchmark indices, leading to what is called tracking error, but some funds make nonsense of index funds by trying to actively manage such funds, when all they are supposed to do is passively follow the index. This gives rise to “outperformers” among index funds—a contradiction in terms.

HDFC Index Fund managed a return of 21.13% over 10 years when the Nifty has gone up 17.10%. ICICI Prudential Index Fund managed a return of 21.48% over eight years with growth in the Nifty at 20.15% and UTI Nifty Fund managed returns of 13.38% over 10 years with growth in the Nifty at 12.92%.

This outperformance could be partially due to an element of active management. To enhance returns, ICICI Prudential Index Fund invested 15.48% of Rs96.6 crore in the futures market on 31 March 2010. UTI Nifty Fund too has put some money in futures and bank deposits. This shows how index funds are trying to manage money actively to outperform the benchmark and show greater returns. They are also known to be trying to time the market, something that explains underperfomance (fund managers are bad at timing) leading to tracking error in some cases.

Among the index funds, LIC MF Index Fund and Birla Sun Life Index Fund recorded the highest tracking errors

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Government treads cautiously on SJVN’s IPO

After receiving poor retail interest in the recent follow-on public offers of NTPC, REC and NMDC, SJVN has been priced at Rs23-Rs26 to woo retail investors

The government seems to have priced the Satluj Jal Vidyut Nigam Ltd (SJVN) initial public offer (IPO) at a fairly low price after receiving lackadaisical retail investor response from its recent follow-on public offer (FPOs) for various State-run units.

NTPC’s FPO was priced at Rs201 and got a meagre 0.1646 times retail subscription. Similarly, Rural Electrification Corporation Ltd’s (REC) FPO priced at Rs203, received just 0.22 times subscription from the retail investor category.

NMDC Ltd priced at Rs300 at the lower band received 0.21 times retail subscription. The only exception was United Bank of India which was issued at a price band of Rs60-Rs66 and was subscribed 9.80 times in the retail investor category. Another government owned entity, NHPC Ltd, which was priced a bit lower at a price band of Rs30-Rs36 than REC and NTPC, received 3.87 times subscription from retail investors.

The government holds 75% stake in SJVNL and the remaining 25% is held by the Himachal Pradesh government. SJVN has given a 5% discount to retail investors and its employees.

The object of the issue is listing on the stock exchanges; SJVN will divest 10.03% stake in the company by issuing 41.50 crore shares.

Incorporated in 1988, SJVN (erstwhile known as Nathpa Jhakri Power Corporation Limited or NJPC) is a hydroelectric power generation company originally established as a joint venture between the Centre and Himachal Pradesh to develop and operate the the Nathpa Jakhri Hydro Power Station (NJHPS).

The company posted a profit after tax (PAT) of Rs775.37 crore in the nine-month period ended in the December quarter of 2009. In FY09 and FY08 it recorded PAT of Rs759.32 crore and Rs716.91 crore against a total income of Rs1,634.84 crore and Rs14,62.28 crore respectively. It had a net cash flow of Rs215.71 crore in its December quarter of 2009. In FY09 and FY08 it had net cash flow of Rs577.84 crore and Rs72.56 crore respectively.

SJVN’s P/E stands at 13.79 for the year ended March 2009 while its earnings per share (EPS) stand at Rs1.77 based on the year ended March 2009 earnings. The peer group hydropower companies like KSK Energy Ven and NHPC Ltd carry a price earnings ratio (P/E) of 137.7 and 23.5 respectively.

JM Financial Consultants Pvt Ltd, IDFC Capital Ltd, IDBI Capital Markets Services Ltd and SBI Capital Markets Ltd are lead book-running managers for the IPO. The issue opens for subscription on 29 April 2010 and closes on 3 May 2010. Ratings agency CRISIL has assigned an ‘IPO Grade 4’ to the issue. SJVN plans to raise Rs954.50 crore-Rs1,079.00 crore at a price band of Rs23-Rs26.

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