ICICI Prudential & Nippon India released India’s first auto sector ETF, should you invest?

Mutual fund houses such as ICICI Prudential and Nippon India have announced the launch of the country's first Nifty Auto ETF.

About ETFs:

• ICICI Prudential Nifty Auto ETF (IAUTO) and Nippon India Nifty Auto ETF (NAUTO) opened on 5th Jan for subscription. 
• The exchange traded funds will track Nifty Auto Index and aim to generate returns in line with those of the benchmark.
• This index has 15 stocks of companies manufacturing passenger vehicles, heavy commercial vehicles, two and three wheelers, tyres, batteries and forgings. No single stock can have a weight of more than 33 percent in the index. 

• The price to earnings ratio of the index stands at 60.71.
• The index is rebalanced semi-annually.
• Since these ETFs are passively managed, they have very low expense ratios.

This is because auto sector has been struggling till now due to following reasons:

• COVID-19 pandemic led to many individuals and corporates postponing their vehicle purchases. 
• Global semiconductor shortage has hurt auto companies in India severely impacting production.
• Commodity prices have been increasing in the past year leading to higher input costs.
• High debt among all auto companies.

So why this sudden interest in the auto sector?

This is because the sector shows hopes of stability and growth due to following factors:

• Commodity prices are also seen to be stabilizing. Despite the Omicron variant hitting the world towards the end of CY2021, the global economy is on track for a recovery. Experts are of the opinion that this cyclical sector may see better times ahead.
• There is also expectation of strong rural demand, strong balance sheets of listed companies, uptick in export revenues.
• Semiconductor situation also seems to be stabilizing. 
• The whole sector seems to be at the cusp of resurrection due to Electric Vehicles. Due to increasing fuel prices and high pollution in metro cities of India, there is huge demand for Electric Vehicles and the supply is just coming in. This is a big opportunity because it will increase the rate of replacement in the auto sector to a huge extent i.e. everyone with ICE (internal combustion engine) cars want to switch to EVs due to high operational costs despite their old car being in perfect condition. This will translate to higher than usual demand for cars in the coming years.

Risks associated with these auto ETFs:

• Being sector-specific offerings, these ETFs carry high risk compared to a diversified equity fund.
• Investor returns are tied to the performance of the auto sector which have a price to pay for EV opportunity. Evolving clean fuel technologies and rolling out EVs ask for capital expenditure which will further burden the already debt laden auto companies. The competition can also increase over a period of time which may bring down the margins of automakers.

What should you do?

Investing in an out-of-favour sector means that you must be prepared for bouts of volatility. These index ETF offerings are not meant for beginners. One should have patience and be invested long enough for the EV card to play out well for the sector and enjoy good return on investment.