The Union Cabinet has recently approved launching a bond ETF (Exchange Traded Fund). Called the Bharat Bond ETF, this fund will track the index comprising debt securities of 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 20,2019. ETFs are passively managed mutual funds that aim to generate a similar return as that of the index they follow. ETFs are traded on the BSE and NSE. The AMC plans to mop up about ₹7,000 crore from the NFO, sources say.
Unlike existing ETFs in India, the Bharat Bond ETF will have a defined maturity date just like bonds and fixed maturity plans of mutual funds. On maturity, investors will get the investment proceeds along with returns. Edelweiss MF is launching two series of Bharat Bond ETFs — one matures in April 2023 and the other after 10 years (ie April 2030). Only growth option is offered here.
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 maturity and coupons received from those bonds will be reinvested in the fund. Post the NFO period, ETF units will be listed on NSE and BSE. Through demat accounts, investors can buy and sell units at the prevailing market prices. Edelweiss MF plans to launch a fresh tranche in both ETFs, once a year. The older three-year and 10-year tranches, will continue to be available with shorter residual maturity in the secondary market. It may also be launched as a further fund offer (FFO).
Edelweiss MF charges an expense ratio of 0.0005% for managing the Bharat Bond ETF. This is the cheapest among MF schemes and ETFs in India. A lower expense ratio helps earn higher returns than a scheme with a higher expense ratio.
Series to track index
Bharat Bond ETFs will track the index constituted by the 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 benchmark. This index that measures the performance of portfolio of AAA rated bonds issued by 13 government owned entities.
The total number of constituents in the index 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. The REC, NABARD and PFC are the top three issuers comprising 45% of the weightage in the index. The maturity date of the index is April 15, 2023; hence, it is same for the ETF too.
Similarly, Bharat Bond ETF–April 2030 will track ‘Nifty Bharat Bond Index–April 2030’ as benchmark. This will measure the performance of portfolio of AAA-rated bonds issued by 12 PSUs. The total number of constituents in the index is 50. NHAI, IRFC and Power Grid Corporation are the top three issuers comprising 45% of the index weightage. The maturity date is April 15, 2030. Since these ETFs have a defined maturity structure, it would be easier to predict the returns that they are likely to deliver at 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% and 7.52% in the ETFs maturing 2023 and 2030, respectively.
Note that these returns are indicative and not guaranteed by the MF or the government.
Post the NFO period, investors can buy these ETF units on the exchanges. According to Edelweiss, the indicative yield (Yield to Maturity) of each ETF series will be displayed on the AMC’s website daily.
Trading volume is key
Liquidity or the trading volume plays an important part while you transact on the exchanges.
In India, most debt ETFs are thinly traded which makes ETF transactions cumbersome.
Liquidity in an ETF is mostly determined by corpus and market makers. Normally, a 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 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. This will enable active participation of market makers.
Second, units of Bharat Bond ETFs are now eligible for repo transactions. Though the corporate bonds repo market in India is at a nascent stage, there is a chance that market makers can use their holding in Bharat Bond ETFs to raise funds.
The bonds held are rated the highest grade of AAA. Debt instruments with this rating are considered to have the highest degree of safety for timely servicing of financial obligations. Such instruments carry the lowest credit risk. These entities are backed by government, ensuring safety of capital.
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 the PSU banks on their deposits of similar tenure. Conservative investors including retirees, whose investment horizon matches the tenure of the available bonds, can consider investing in these bonds.
Bharat Bond ETFs are treated at par with debt mutual funds where the sale of units after 36 months from the date of purchase qualifies for long term capital gains tax; the gain is taxed at 20% with indexation.
Points to note
Any deterioration of credit quality of the bonds held in the basket of the index may lead to capital erosion for investors.
Considering the higher allocation to a few issuers, investments may 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. These FoFs enable investors to participate in the underlying ETFs without a demat or a broker’s account.
Published - December 08, 2019 10:50 pm IST
