Weekly Musings – NFO Pick (HDFC Nifty Realty Index Fund)

10 Mar 2024 , 07:51 AM

WHAT IS A REALTY INDEX FUND

This is a sectoral index fund that is pegged to the performance of the realty sector in India. Unlike an active sectoral fund, this is a passive sectoral fund which prefers to invest in the index rather than indulge in stock selection. In this case, the fund will create a portfolio that exactly mirrors the underlying Realty Index. The fund managers do not select stocks, but create a portfolio the replicates the index stocks in the same proportion and only focus on reducing the tracking error to the minimum.

Realty index funds, despite being passive funds, are high risk funds as the fortunes of the fund are closely related to the performance of the Nifty Realty Index. However, being an index, it is an automatically diversified portfolio. The added advantage in an index fund over an index ETF is that the investors do not require a trading account and demat account with a broker, which is mandatory if you want to buy and sell ETFs.

WHAT ARE THE TRIGGERS FOR THE GROWTH OF REALTY SECTOR IN INDIA

The growth of any large economy in the last 50 years has been concomitant with the rapid development in the real estate space. This includes countries like Japan, China, Europe, the US etc. Hence, it is only likely that in India too, real estate can be a big trigger of growth. Here is why the realty sector in India is looking so attractive.

• The realty sector in India is just coming out of a 15-year long period of weak growth. In terms of growth triggers, there are several triggers like rising per capita incomes, premiumization of property, formalization of the sector, greater safety checks through RERA etc. All these factors have already triggered a rally in the realty stocks.
• At a real estate developer level also there have been several corporate triggers. Most realty companies have strengthened their balance sheets by reducing the debt levels with some even moving towards zero-net debt status. Others have focused on the quality of assets and on the quality of cash flows on a regular basis.
• The Indian real estate sector (as per a report by Knight Frank) is likely to see its contribution grow from $0.48 Trillion in 2022 to $5.8 Trillion in 2047. The share of realty sector in GDP is also set to grow from 7.3% today to 15.5% by 2047. This kind of growth compares with similar periods of growth in the US and China also.
• The overall realty sector demand is likely to be driven by several factors. Apart from rising demand for home ownership, the IT and BFSI spaces are driving demand for commercial spaces. Retailers are driving the demand for malls, while temporary living in the form of hotels and service apartments is also on the rise. In addition, there is growing demand from SEZs and massive scale data centres.
• Home loan rates in India may have risen in the last 2 years, but are still below the peak levels of 2012. Also, with the RBI likely to cut rates in the second half of the current year, the realty stocks may find themselves in a sweet spot as home affordability is also going up at the same time.
• The increasing trend of urbanization means that the urban population is likely to rise to 543 Million by the year 2025 and further to 676 Million by 2035. This is likely to trigger huge demand for housing in most of the key urban centres. This is already visible in the form of a sharp recovery in new launches and sales in terms of square feet sold.
• There have been several regulatory changes like the RERA Act, Benami Transactions Act, 100% FDI in township projects, interest subsidy for low cost housing, emergence of REITs to invest professionally in realty etc, which have also given a boost to the sector.

One point to remember is that Realty remains a high risk play, although returns are expected to justify this risk. However, realty has been a clear outperformer on a regular basis post RERA in 2017. That is the trend-shift to bet on by investing in the HDFC Nifty Realty Index Fund NFO.

WHY INVEST IN HDFC NIFTY REALTY INDEX FUND NFO

There are several reasons for investors to take exposure to the HDFC Nifty Realty Index NFO.

• It will help the investors to ride the structural tailwinds of the real estate sector in India. There are several evolving factors that are likely to be value accretive to the Indian realty sector. Rising income levels, rising per capital incomes, increased urbanization, shift of the Indian economy to a $5 Trillion economy as well as the passage of RERA are all likely to be major positives for the Indian realty sector. It is also interestingly poised at this juncture, and so this fund allows investors to make the best of it.
• The underlying fundamentals of listed realty companies are gradually improving in the last few years and has come a long way since the crisis of 2008 and 2009. Most realty companies have sharply improved their balance sheets and also improved their metrics of profitability. In addition, the gradual premiumization and formalization of the realty sector in India is also likely to be value accretive.
• The HDFC Nifty Realty Index Fund offers exposure to multiple stocks through a single fund, without the risk or the bias of stock selection. There is no need to spend time and energy on stock selection since the Realty Index offers a pre-designed portfolio of high quality of realty companies with the benefits of diversification.
• The vast exposure of the HDFC group to the realty sector as a lender and as an investors is a big advantage,. Also, the HDFC AMC has been among the largest AMCs in India in terms of AUM with an enviable range of products. Just to give an example, in the passive range itself, HDFC AMC offers 19 ETFs, 18 index funds and 3 Fund of Funds (FOFs). Its passive funds are spread across market cap, sectors, commodities, smart beta funds and global asset classes.

Realty sector got a big boost with the RERA and now there are the additional headwinds in terms of income growth, premiumization and formalization. The fund allows investors to play that theme with the backing of timing and pedigree.

RISKS OF INVESTING IN HDFC INDEX REALTY FUND NFO

As much as there is a case for investors to invest into the HDFC Index Realty Fund, there are also some distinct risks that the investors must be familiar with.

• The real estate sector, by default is cyclical in nature and historically it has gone through sharp crests and troughs. Obviously, that is likely to impact the performance of these realty companies also. Some of the key risks in this regard include changes in government policy, macroeconomic slowdown, oversupply etc.
• The realty index has shown much sharper correction in market downturns compared to the performance of the diversified indices like Nifty 50 or the more diversified Nifty 500. Hence, investors must be prepared for much sharper NAV erosion in times when the particular index goes into a downturn.
• The Realty index, which is the benchmark for this fund, only focuses on one aspect of the real estate sector i.e. the real estate development sector. There are many specific related themes like building materials, infrastructure development and housing finance that are outside the purview of the Nifty Realty Index.
• While it is a passive scheme, it must be noted that the HDFC Nifty Realty Index Fund is still a sectoral fund and hence all the risks of substantial sectoral exposure are there int his fund. That can substantially add to the risk metrics of the investor portfolio.

Most of these risk can be mitigated but keeping this fund as a small share of your overall investments.

WHO SHOULD INVEST IN THE HDFC NIFTY REALTY INDEX FUND

This fund is best suited to investors who are willing to make a small allocation of their portfolio to the realty sector in India and prefer to do it the passive way. The fund offers a passive approach to participate in the realty sector through a diversified portfolio. Ideally, this fund is suited to investors who have a high tolerance for volatility since such sectors fund are cyclical by default and are vulnerable to substantial bouts of volatility.

However, this fund is suited to investors who are seeking a low cost investment option in the realty sector. Index funds tend to have a much lower total expense ratio (TER) compared to active funds and that benefit tends to get passed on to the investors in the form of higher returns. However, it is suggested that such sectoral fund must not be the core and must only be as supplementary to the core portfolio, for the sake of generating long-term alpha.

GLANCE AT THE HDFC NIFTY REALTY INDEX FUND NFO

Here are some details of the HDFC Nifty Index Realty Fund NFO you must know to decide on investing in the fund.

• The NFO of HDFC Nifty Index Realty Fund opens for subscription on March 07, 2024 and will close on March 21, 2024. The scheme will open within two weeks for continuous sale and purchase at NAV-linked prices. On the Standard SEBI Risk-O-Meter, the HDFC Nifty Realty Index Fund will be ranked as a High Risk Fund.
• The HDFC Nifty Index Realty Fund NFO offers an opportunity to investors to participate in a diversified portfolio of real estate companies. The only difference is that instead of selecting individual stock, the fund will invest in the index as a whole, structured as a passive index fund to reduce the fund manager bias in selection.
• Entry loads do not exist in India. The HDFC Nifty Realty Index Fund, being a sectoral index fund, will not have exit loads also. This is to keep the cost of the fund as low as possible on an overall basis. However, being a cyclical and high risk fund, it is advisable to keep a time frame of minimum 6-7 years to realize the potential of the sector.
• In the NFO, investors can put in applications for a minimum of ₹100 and in multiple of ₹1 thereafter. Like in the NFO, the additional purchases on an ongoing basis will also be allowed at a base of ₹100, and in multiples of ₹1 thereafter.
• The fund offers Regular and Direct plans for the investors. In addition, investors can either choose the Growth option or the IDCW (income distribution cum capital withdrawal) option. Dividend plans offer payout and reinvestment options. It must be noted that the growth offers automatic reinvestment of intermediate gains.
• The HDFC Nifty Index Realty Fund will be benchmarked to Nifty Realty Index TRI. The total returns index (TRI) considers not only the capital appreciation but also the impact of dividends declared by the companies so that a more lucid and reliable picture of fund performance is available to the investor.
• In terms of the fund management, Nirman Morakhia and Arun Agarwal will be managing the fund. Being a passive fund, there will not be too much of stock selection involved as the primary intent of the fund, in this case, is to reflect the performance of the Realty Index with minimal tracking error.
• The HDFC Nifty Index Realty Fund is a passive index equity fund benchmarked to the Nifty Realty Index TRI. Effective Budget 2023-24, dividends on equity funds will be taxed as other income at the peak applicable rates. Short term capital gains from the fund (if held for less than 1 year) will be taxed at 15%. The long term capital gains from the fund (if held for more than 1 year) will be taxed at 10% flat (without indexation) but after a threshold exemption limit of ₹1 Lakh for equity gains.

The HDFC Nifty Index Realty Fund NFO is an opportunity for investors to take a passive exposure to the Indian realty sector. This is a good opportunity as the sector still continues to be highly volatile in terms of returns and performance. An index does away with the stock selection risk by benchmarking it to the underlying realty index.