Last Updated on December 29, 2021 at 6:08 pm
This is a review of ICICI Prudential Nifty Low Vol 30 ETF FOF, an open-ended fund of funds scheme investing in ICICI Prudential Nifty Low Vol 30 ETF. We try to answer two main questions that investors should ask before considering an investment in this FOF.
They are: 1: Does low volatility investing work? If yes, what should investors expect from this strategy? 2: Does it make sense to invest in ICICI Prudential Nifty Low Vol 30 ETF FOF?
About the index: The NIFTY100 Low Volatility 30 Index chooses 30 stocks with the lowest price volatility among the “large cap universe” (as defined by SEBI) – Nifty 100. The index approximately mimics an “equal weight index” (at the time of writing). This is because any stock with a turnover lower than the lowest stock in the NIfty 50 cannot have a weight of more than 3%. Stock turnover is a measure of liquidity and is defined by traded volume divided by shares available.
Volatility is defined as the standard deviation of daily price returns for the last year. The stock weights are defined as
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𝑤 =(1/𝑉𝑜𝑙𝑎𝑡𝑖𝑙𝑖𝑡𝑦)/∑(1/𝑉𝑜𝑙𝑎𝑡𝑖𝑙𝑖𝑡𝑦) –> ∑ refers to a sum over the 30 stocks
According to the Feb 2021 factsheet of ICICI Prudential Nifty Low Vol 30 ETF, the stocks in the index are:
- Bajaj Auto Ltd. 3.79%
- Hero Motocorp Ltd. 3.02%
- Bosch Ltd. 3.14%
- HDFC Bank Ltd. 3.39%
- Kotak Mahindra Bank Ltd. 2.50%
- Ultratech Cement Ltd. 3.95%
- ACC Ltd. 3.67%
- Pidilite Industries Ltd. 3.61%
- Larsen & Toubro Ltd. 3.51%
- Dabur India Ltd. 3.97%
- Hindustan Unilever Ltd. 3.37%
- Nestle India Ltd. 3.31%
- Britannia Industries Ltd. 3.22%
- ITC Ltd. 3.18%
- Asian Paints Ltd. 3.10%
- Colgate – Palmolive (India) Ltd. 2.97%
- Marico Ltd. 2.92%
- HDFC Ltd. 2.70%
- Coal India Ltd. 3.46%
- Indian Oil Corporation Ltd. 3.91%
- Reliance Industries Ltd. 2.82%
- Dr Reddy’s Laboratories Ltd. 3.10%
- Cipla Ltd. 3.08%
- Power Grid Corporation Of India Ltd. 4.13%
- NTPC Ltd. 3.68%
- Wipro Ltd. 3.53%
- Tata Consultancy Services Ltd. 3.51%
- Infosys Ltd. 3.24%
- HCL Technologies Ltd. 3.19%
- Tech Mahindra Ltd. 2.90%
The index is generally heavy on FMCG and IT, as can be seen from ICICI Prudential Nifty Low Vol 30 ETF’s sector allocation history.
About the underlying fund ICICI Prudential Nifty Low Vol 30 ETF:
- Launch date: July 2017
- AUM (Feb 2021): 272 crores
- TER: 0.42% –> One can expect the direct plan of ICICI Prudential Nifty Low Vol 30 ETF FOF to have about 0.1% to 0.5% extra TER on top of this. We will know for sure only after the fund opens, and daily TER data is available. Please note that ICICI Prudential Nifty Low Vol 30 ETF FOF will have to work at least five times harder to keep pace with a Nifty or Sensex index fund. Then comes the issue of beating them on an absolute basis!
1. Does low volatility investing work?
Let us now proceed to discuss the first of the three questions mentioned above. We must understand the big difference between comparing a low volatility index vs a market-cap weighted index and comparing a low volatility ETF vs a market-cap-weighted index.
The difference lies in the TER as noted above and also the demand for the ETF. Retail ETF investors buy and sell units at market price, not NAV. And the price is set by the demand and supply in the pool of ETF investors. Ideally, an authorized participant (AP) appointed by the AMC should remove deviations from price and NAV. Ideally, the price should fluctuate equally above and below the NAV. This rarely happens: Indian ETF Liquidity: Here is how you can select ETFs.
Ideally, Price-Nav deviations only depend on how active the AMC or APC is in arbitrating out the difference and not the AUM. However AUM is typically an incentive!
Fund of fund investors should note that the fund manager will buy the underlying ETF at its market price, except perhaps during the NFO period. The most dramatic example of how AUM inflow into an ETF via a fund of fund “motivated” the AMC or its AP to reduce price nav deviations is shown below.
The blue dots represent (price – nav)/nav of Motilal Oswal Nasdaq 100 ETF. One can immediately tell when MO N100 Fund of Fund was launched – the red rectangle. This was in the middle of a downturn in N100 and notice how the rush of funds into the FOF literally extinguished the huge price-nav deviations – so much that the March 2020 crash is barely visible (demand-supply mismatch shoots up during a crash/turbulence)
The orange dots show the same quantity for ICICI Pru Low Volatility 30 ETF. ICICI has done a much better job keeping deviations low (MO N100 ETF deviations will always be higher as it invests in a market open at a different time zone).
However, if you look inside the black rectangle, the deviation zoomed during the March 2020 crash. This is how the price and NAV differed during this period.
When we look at rolling return graphs below, we shall be comparing the total return indices without complications of TER and price-nav deviations. In reality, these factors play a big role.
Since July 2017:
- Nifty 100 TRI has moved by 55.75% (absolute change).
- The NIfty 100 low volatility 30 Index TRI by 60.32%.
- Nifty 50 TRI by 60.08%.
- UTI Nifty 50 index fund direct plan by 58.22%
- ICICI Low Volatility 30 ETF price has changed by 58.18%
The ETF is priced more than four times more. The fund of the fund will at least have an extra TER of 0.1% (the direct plan, that is). Even if low volatility works as a concept (we shall see this below), the ETF implementation and a fund of fund buying the ETF will mess it up.
We also have to consider the higher concentration of the top few stocks in the Nifty/Sensex and how this can drive returns for years. An almost “equal weight” index like the Nifty 100 low volatility 30 may find the going harder during this period (e.g. Late 2017 to March 2020)
The inflow of AUM into ICICI Prudential Nifty Low Vol 30 ETF FOF will help reduce the price nav deviations. However, “low volatility” investing has a much lower charm than the Nasdaq 100 with the benefits of “international diworsification”. Even if the price = nav, the likely five times higher TER (of the FOF) will make beating a Nifty 50 index fund tough. Here is the ICICI Nifty index fund’s performance, the low volatility ETF price since inception compared with Nifty 100 and Nifty 50.
Now, does low volatility investing “work” as an “idea”? The short answer is “yes; not all the time and not in the way we want it to, but it does work”. Shown below are 202 10-year rolling return data points (based on monthly data) from May 1994 to Feb 2021 of the MSCI USA Min volatility (large + midcap) total return index with MSCI USA index (large + mid cap) and MSCI USA (large cap) index.
The minimum volatility index has done fairly well over a ten-year period. Even during periods when there is no outperformance, the lower standard deviation (volatility) or, the lower drawdown (fall from a peak) would result in a better risk-adjusted return (without expenses). So there is enough evidence to suggest that over a 10-year period, the idea “works”.
Similar arguments can be better for the Nifty 100 low volatility 30 index too.
Max drawdown of Nifty 100 Low volatility 30 TRI compared with Nifty 100 TRI
Conclusion: Before expenses, a low volatility strategy ‘works’ in a sense, there is a reasonable chance of getting an absolute higher return “over the long term” and an even better chance of getting a better risk-adjusted return since the low volatility is relatively “guaranteed”. However, expenses and ETF buy/sell demand can change the equation dramatically.
Does it make sense to invest in ICICI Prudential Nifty Low Vol 30 ETF FOF?
We recommend that investors not buy the CICI Prudential Nifty Low Vol 30 ETF FOF at least for a year after launch. We can see how the AUM builds (NFOs are launched depending on uninformed regular plan purchases and not finicky direct plan purchases), how the price-nav fluctuations of the underlying ETF changes, how the expense ratio fluctuates (yeah, that is a thing!), how the FOF fares against the Nifty or Nifty 100 for a year and then take a call.
We are, however, not hopeful of a change even after a year. Although the idea itself is good (readers may recall I am using this strategy to build a direct equity portfolio; also see: How to buy your first stock without breaking your head!), the expenses would effectively stamp out the possibility of higher returns even if the lower volatility and lower drawdown remain.
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