While the fund promises a lucrative play on India growth story, there are a few pitfalls

The government is set to launch a new exchange-traded fund (ETF) based on the central public sector enterprises (CPSE) index. Managed by Reliance Mutual Fund, this will be the second CPSE ETF, the first being launched in March, 2014.

The fund aims to provide investors the opportunity to invest in a diversified basket of public sector companies and benefit from the growth potential over the long term.

It will mirror the performance of the CPSE Index while the portfolio will comprise shares of the 10 biggest PSUs: ONGC, GAIL, Coal India, IndianOil, Oil India, Power Finance Corporation, Rural Electrification Corporation, Container Corporation, E n gi n eer s In di a a n d B harat Electronics.

To find out if it's a good idea to invest in the fund, one shouild consider how the first CPSE ETF has been performing. When it was launched, the government had offered an upfront discount of 5% on the issue price to sweeten the deal for investors.

A year later, the government issued `loyalty' units in the ratio of 15:1 to eligible retail investors who remained invested since the new fund offer, which amounted to an additional discount of 6.66%. It is expected that the new CPSE ETF will also offer similar discounts and bonus, providing an attractive entry point for retail investors. The low valuations of the underlying shares also make it a compelling offer--the stocks that form the CPSE ETF are trading at a much lower Price to Earnings (PE) ratio and have higher dividend yields than the broader market.

While the CPSE Index trades at a PE multiple of 11.44 and dividend yield of 4.07%, the Nifty 50 index is available at 22 times and 1.35% respectively .A low expense ratio of 0.065% also ensures that costs do not eat into the gains made by the scheme over time.

The ETF claims to offer investors a play on the India growth story through a diversified basket of PSU stocks. But a closer inspection of the composition of the underlying index suggests that the portfolio is far from diversified. Three stocks -- ONGC, Coal India and IndianOil--together constitute around 63% of the entire portfolio.

The portfolio is also skewed towards a few sectors, with energy, metals and financial services making up 90% of the portfolio. This lends a higher risk element despite the fact that the stocks are some of the biggest names in their respective sectors.

The performance of the first CPSE ETF has been impressive. Since its inception, the fund has clocked 14.5% annualised return while the Nifty 50 index gained 7.5% during the same period. After adjusting for loyalty units, retail investors have made a gain of 17.2%. Over the past year, the fund delivered 17.43% return even as the Nifty 50 index clocked 2.8%.

This effectively makes it the best performing large-cap fund. But this performance needs to be put in context. The fund reached its peak NAV within two months of launch supported by factors such as government oil price deregulation and a fall in crude prices.

Investors also believed that the efficiency of public sector companies would improve under the Modi government. The fund's returns have been driven by commodity price trends as the index is skewed towards commodity businesses.

Experts argue that this is a speciality fund an not a diversified equity fund. Investors should treat this as a sector or thematic fund. You can opt for partial allocation within the 10% tactical allocation in the portfolio.

Any changes in the policies of the promoter could have a bearing on the entire basket. Retail investors should not over-expose their portfolio to such a concentrated bet. Most private sector businesses in the respective sectors are run far more efficiently, and are therefore awarded expensive valuations.