Personal Finance

Should you invest in the new Bharat Bond ETFs?

Dhuraivel Gunasekaran | Updated on July 11, 2020 Published on July 11, 2020

It is a good investment option if you can hold on to your units till maturity

A new series of Bharat Bond ETFs offered by Edelweiss Mutual Fund is now open for subscription between July 14 and 17. The first issue was in December 2019.

The latest issue has two variants — Bharat Bond ETF - April 2025 that matures after five years and Bharat Bond ETF - April 2031 that matures after 11 years. Indicative yields of these ETFs at the time of the new fund offer (NFO) work out 5.56 and 6.73 per cent, respectively.

They invest only in AAA rated bonds issued by public sector undertaking (PSUs).

Structure

Exchange-traded funds, like equity shares, are passively managed mutual funds traded on BSE and NSE. An ETF simply copies an index and endeavours to accurately reflect its performance.

Bharat Bond ETFs follow the Nifty Bharat Bond indices that track the AAA rated bonds issued by PSUs. Unlike other ETFs, Bharat Bond ETFs 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, and then the ETFs would be wound up.

Edelweiss MF charges an expense ratio of 0.0005 per cent for managing the Bharat Bond ETFs. This is the cheapest among MF schemes and ETFs in India. A lower expense ratio helps earn higher returns compared with a scheme with a higher expense ratio.

Two series of Bharat Bond ETFs that were launched in December 2019 are traded actively on exchanges with reasonable liquidity.

 

Earlier issues

Bharat Bond ETF - April 2023 is now available with the residual maturity of 2.76 years. The average of the daily traded volume of the ETF since its date of listing on NSE is around ₹3.2 crore. Yield-to-maturity (YTM) as on July 9 works out 5.1 per cent.

YTM, in layman terms, is an indicative return that you will get if you hold an ETF till its maturity.

The other variant, Bharat Bond ETF - April 2030, is available with the residual maturity of 9.76 years now. Its average daily traded volume on NSE is ₹3.7 crore and the YTM is 6.68 per cent.

These ETFs have delivered an absolute return of 7.4 per cent and 9 per cent, respectively, since their date of allotment, thanks to the frequent rate cuts by the RBI.

The daily Tracking Error (TE) calculated from the date of listing for these ETFs is 0.27 per cent 0.52 per cent, respectively, which is higher than the 0.04 per cent of the ETFs tracking Nifty 50 and Sensex ETFs.

Should you invest?

As a retail investor, it is better to look at the factors such as quality of the portfolio, interest-rate risk, liquidity, taxation and returns on comparable products before investing in these ETFs.

Quality: These ETFs invest only in AAA rated bonds issued by PSUs. Debt instruments with this rating are considered to have the highest degree of safety with regards to timely servicing of financial obligations. Such instruments carry the lowest credit risk. Further, these entities are backed by Centre, ensuring capital safety.

While looking into the constituents of the portfolio, the Nifty Bharat Bond ETF - April 2025 index holds 12 PSUs. The top five holdings — PFC, REC, Power Grid Corporation, NHB and IOC — account for 64 per cent of the overall portfolio. The Nifty Bharat Bond ETF - April 2031 index holds eight PSUs. The top five — PFC, REC, Power Grid Corporation, NHAI and Nuclear Power Corporation — account for 74.8 per cent of the overall portfolio.

Considering the higher allocation to a few issuers, investments could be exposed to concentration risk. Though default is a very rare occurrence (or nil) in the PSU bond space, any deterioration of the credit quality of the bonds in the basket of the index may lead to capital erosion.

Interest-rate risk: If you wish to buy these ETFs during the NFO and hold till maturity, the interest-rate risk is almost nil. But if you wish to sell or buy the bonds through the exchange, you should take note of the price risk.

Prices of the bonds fluctuate based on macro events such as RBI policy measures, inflation and also credit quality of the bonds. When interest rate falls, the value of the bond increases and vice versa.

Liquidity: If you want to buy or sell these ETFs on exchanges, the liquidity (or the trading volume) matters. Liquidity is mostly determined by the corpus and market makers.

In India, most ETFs are thinly traded. However, the two earlier issued Bharat Bond ETFs are traded with decent liquidity on NSE (see table). Note that the SEBI has mandated multiple market makers for these ETFs to ensure liquidity.

Peer comparison: For taxation, Bharat Bond ETFs are treated at par with debt mutual funds. Sale of units after 36 months from the date of purchase qualifies for long-term capital gains tax at 20 per cent with indexation.

The indicative yields of Bharat Bond ETF -A pril 2025 and Bharat Bond ETF - April 2031 during NFO work out 5.56 and 6.73 per cent, respectively.

This instrument can be compared with PSU bank fixed deposits, RBI savings bonds, tax-free bonds and MF categories such as corporate bond funds and banking and PSU debt funds.

Bharat Bond ETFs score over rates offered by PSU banks on their FDs and RBI’s seven-year floating rate savings bonds on a post-tax basis. Income from bank FDs and RBI savings bonds are taxed as per the investor’s tax bracket.

A back-of-the-envelope calculation shows that the post-tax returns of these ETFs are 1.2-1.4 per cent higher than that of PSU bank FDs and around 0.7 per cent higher than that of RBI savings bond.

Currently, SBI offers 5.7 per cent rate for retail domestic term deposits for three years and more, and RBI’s seven-year floating rate offer 7.15 per cent.

Tax-free bonds that are actively traded in the secondary markets are currently available with a YTM of 4.5 per cent (with residual maturity of around 11 years), which translates to a 6.4 per cent pre-tax yield for investors in the 30 per cent bracket. This shows that the Bharat Bond ETF with a similar maturity profile scores over tax-free bonds.

The average YTM of the MF categories — corporate bond funds and banking and PSU debt funds — is 5.9 per cent and 5.5 per cent, respectively (as on June 30, 2020). This is almost on par with, or slightly lower than, the yields offered by the bond ETFs.

Hence, for those in the higher slabs, the post-tax returns on the Bharat Bond ETFs would be better than those on competing instruments.

Our take

Bharat Bond ETFs provide a good opportunity to retail investors to participate in the corporate debt market while taking the lowest credit risk.

Bharat Bond ETF is a good investment if you can hold on to your units till maturity.

Conservative investors, including retirees whose investment horizons match the tenure of the available bonds, can consider investing in these bonds.

However, periodical income option is not available.

The fund house also launches fund of funds (FoFs) that enable investors to participate in the underlying ETFs without a demat or a broker’s account and allow a systematic route to invest.

Investors can also buy units of the earlier launched Bharat Bond ETFs on NSE. Currently, yields of these ETFs are also attractive and trade with decent liquidity.

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Published on July 11, 2020
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