Personal Finance

Should you buy Bharat Bond ETFs?

Dhuraivel Gunasekaran | Updated on December 07, 2019 Published on December 07, 2019

A safe bet for conservative investors, it is the cheapest among exchange-traded funds

The  Cabinet  recently approved the launch of a bond ETF (exchange-traded fund). Called the Bharat Bond ETF, this fund will track the index comprising the debt securities of PSUs (public sector undertakings) with the highest credit rating.

Edelweiss Mutual Fund is launching the NFO (new fund offer) which is open for subscription between December 12 and December 20.

ETFs are passively managed mutual funds that aim to generate a  return similar to the index they follow. ETFs are traded on the BSE and the NSE just like equity shares.

According to sources, the AMC plans to mop up around ₹7,000 crore during the NFO.

Structure

Unlike the existing ETFs,  Bharat Bond ETF will have a defined maturity date just like bonds and fixed maturity plans (FMPs) of mutual funds.

On maturity, investors will get the investment proceeds along with returns. Edelweiss Mutual Fund is launching two series of Bharat Bond ETFs — one matures after three years (i.e., April 2023) and another after 10 years (i.e., April 2030). Only growth option is offered.

These ETFs will invest only in AAA-rated bonds issued by PSUs maturing on or before the maturity of the ETFs. The ETF will hold the bonds till the maturity of the bonds, and coupons received from those bonds will be reinvested in the ETF itself.

Post-NFO period, the units of the ETFs will be listed on NSE and BSE. Through demat accounts, investors can buy and sell the ETF units at the prevailing market prices.

Edelweiss Mutual Fund plans to launch  fresh tranches in both the ETFs, once a year. The older three- and 10-year tranches will continue to be available with shorter residual maturity in the secondary market. It may also be launched as further fund offer (FFO). Edelweiss MF charges an expense ratio of 0.0005 per cent for managing the Bharat Bond ETF. This is the cheapest among MF schemes and ETFs in India. Lower expense ratio helps in earning higher returns than a scheme with higher expense ratio.

Benchmark

Bharat Bond ETFs will track the index constituted by NSE. Each of the ETF series will have a specific index to track.

Bharat Bond ETF - April 2023 will track ‘Nifty Bharat Bond Index - April 2023’ as the benchmark. This index measures the performance of portfolio of AAA-rated bonds issued by 13 government-owned entities.

The total number of constituents in the index currently is 99 as it holds different series of bonds from the same issuer. For instance, the index holds 10 series of bonds issued by PFC. REC, NABARD and PFC are the top three issuers comprising 45 per cent of the weight in the index. The maturity date of the index is April 15, 2023,same as  the ETF.

Similarly, Bharat Bond ETF - April 2030 will track ‘Nifty Bharat Bond Index - April 2030’ as the benchmark. This will measure the performance of portfolio of AAA- rated bonds issued by 12 PSUs. The total number of constituents in the index currently is 50.

NHAI, IRFC and Power Grid Corporation are the top three issuers comprising 45 per cent of the weight in the index. The maturity date of the index is April 15, 2030.

Indicative returns

Since these ETFs have a defined maturity structure, it would be easier to predict the returns  if you hold the ETF till maturity. As per the NFO document, if you invest in the ETFs during NFO and hold till maturity, you will get an annualised yield of 6.59 per cent and 7.52 per cent in the ETFs maturing 2023 and 2030, respectively. Please note that these returns are indicative and not guaranteed by the MF or the government.  According to Edelweiss MF, the indicative yield (YTM or yield-to-maturity) of each ETF series will be displayed in the AMC’s website on a daily basis.

Liquidity

Liquidity or the trading volume plays an important part while you transact in the exchanges. In India, most debt ETFs are thinly traded, which makes ETF transactions cumbersome. Liquidity in an ETF is mostly determined by the corpus and market makers. Normally, large asset size in an ETF implies the likelihood of more active trading in the exchanges. Since the Bharat Bond ETFs are expected to collect a large corpus, there could be  ample liquidity available in these ETFs.

Market makers are authorised participants appointed by the AMCs to keep the price of the ETF, at any point in time, close to the fair value of its portfolio. SEBI has mandated multiple market makers for these ETFs to ensure liquidity. To incentivise market makers for making the market more liquid, SEBI allows AMCs to spend ₹20 crore for such activities. Though the amount is small, this will enable active participation of market makers.

Secondly, units of Bharat Bond ETFs are eligible for repo transactions. This will increase the demand for these instruments.

Suitability

The bonds held are rated AAA. Debt instruments with this rating are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry the lowest credit risk. Further, these entities are backed by Centre, ensuring capital safety.

Bharat bond ETFs provide a good opportunity to retail investors to participate in the corporate debt market while taking the lowest credit risk. The buy-and-hold strategy mitigates the interest-rate risk, too. The yields offered in these ETFs are more or less equal to the rates offered by PSU banks on their deposits of a similar tenure.

Conservative investors, including retirees whose investment horizon matches with the tenure of the available bonds, can consider investing in these bonds.

Currently, Bharat Bond ETFs are treated at par with debt mutual funds, wherein the sale of units after 36 months from the date of purchase qualifies for long-term capital gains tax at 20 per cent with indexation.

Points to note

Deterioration of credit quality of the bonds in the basket of the index may lead to capital erosion. Considering the higher allocation to a few issuers, investments could also be exposed to concentration risk. One needs a demat and broker’s account to transact in the ETFs. Anyway, the fund house is planning to launch a fund of funds (FoFs) scheme.

The FoFs enable investors to participate in the underlying ETFs without a demat or a broker’s account, and allow a systematic route to invest.

Published on December 07, 2019
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