Motilal Oswal Asset Management Company (AMC) launched the Motilal Oswal MOSt Shares M50 ETF recently. Now while exchange-traded funds or ETFs are not new in India, this is the first scheme of its kind. For the M50 ETF is a fundamentally weighted ETF.

An ETF is a kind of index fund, listed on a stock exchange like an equity share. It entails passive investing since it mirrors a chosen index. But while index funds are sold at end-of-the-day net asset value, ETFs can be traded on an exchange anytime during market hours.

The M50 ETF is different, however. That’s because while the underlying MOSt 50 Basket comprises the same universe of 50 shares as the S&P CNX Nifty, the fund determines the weightage or allocation given to these shares based on certain fundamental factors.

“It’s a hybrid. We have married the best of active investing with the best of passive investing,” says Rajnish Rastogi, senior fund manager, Motilal Oswal AMC.

“As an investor, you know your investment universe but the weightages are in the fund manager’s hands. It’s a good product but the barrier is that you need a demat account,” says Hemant Rustagi, CEO, Wiseinvest Advisors.

Actually, Motilal Oswal’s Rastogi admits that as the newest AMC on the block, they had to differentiate itself. “We knew we could only make a difference in the industry if we came out with differentiated products,” he says.

The fund also realised that while index funds typically beat active funds in developed markets, “in India, index funds do beat 70 per cent of the active funds but not 100 per cent of them”. “There was merit in creating a product that is active in selection but passive in execution,” says Rastogi.

For the M50 ETF, the fund chose the Nifty universe of 50 stocks since they’re large cap stocks that generate almost 60 per cent of India’s gross domestic product. But the weightage on which it holds these stocks depends on four factors: return on equity, net worth, retained earnings or the amount of earnings that a company ploughs back into its business, and share price.

“If you have high capital allocation to good companies which are priced relatively cheaper and low capital allocation to companies which are expensive and poor performers, you should ideally be able to construct a product which will outperform the index,” says Rastogi.

The fund’s back-testing has proved just that, he claims. For instance, according to Rastogi, between April 3, 2007 and July 31 2009, the MOSt 50 gave an annualised return of 25.09 per cent against 11.92 per cent for the Nifty with a standard deviation (which denotes risk) of 32.5 per cent a year against the Nifty’s 33.5 per cent.

Oswal also invested $1 million in the MOSt Basket on October 16, 2009 (Moorat trading) before launching the scheme. “Between then and now, the out-performance is 9.1 percentage points over the Nifty,” says Rastogi. From the scheme’s allocation to investors on July 28 to August 13, it out-performed the Nifty by 82 basis points. “In these periods, the MOSt Basket has given significantly higher returns at significantly lower risks,” says Rastogi. It charges an expense ratio, which will be less than 100 bps, says Rastogi. Of course, the real test will come over time.