Bharat Bond ETF: All You Need To Know. Worth Investing?

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The name is Bond… Bharat Bond ETF!

Sorry. I couldn’t stop myself from saying that. 😉

But the correct name of India’s first corporate bond exchange-traded fund (ETF) is Bharat Bond ETF and was launched in December 2019. This is a first of its kind Bond ETF that the Government of India (GoI) has launched. And it is a target-maturity bond ETF, which has a defined maturity (and therefore will invest in AAA-rated bonds of state-run companies with similar maturity).

And since the ETFs are passive products like index funds, Bharat Bond ETF will mirror its holdings to a new index named Nifty Bharat Bond Index.

And as per the government and the issuing AMC, it is being launched to deepen the bond market, allow the small retail investors to participate in bonds markets and ofcourse, provide a way to give more money to state-run government organizations.

I have no doubt that this Bond ETF will be an interesting product in the fixed income category for retail investors.

Why?

Because the Bharat Bond ETF is an easy and low-cost way to invest in bonds from public sector entities. But whether the excitement and the build-up of noise around the ETF are justified? All I would say here is that when it comes to finances (and more so personal finance), excitement is not the word I like to see attached to investments. But that is my view. And to be fair, we should avoid being too quick to judge a newly launched product.

So let’s understand first of all what Bharat Bond ETF is all about.

What is Bharat Bond ETF (Exchange Traded Fund)?

Being the first corporate bond ETF launched in India, this is a new product for every investor.

So what exactly is this product?

Bharat Bond is an Exchange Traded Fund, that will invest money in bonds issued by companies owned the Government of India. Which companies to be exact? The Bharat Bond ETF will replicate its holdings based on the composition of a new index comprising of debt securities issued by state-run firms with AAA rating. As of now, the Bharat Bond ETF will be managed by Edelweiss Asset Management.

Now even before we see how this ETF is structured, it would be a good idea to understand how this Bond ETF will actually work. Here are a few points on the same:

  • The primary aim of Bharat Bond ETF is to create an additional source of funding for Central Public Sector Undertakings (CPSUs), Central Public Sector Enterprises (CPSEs), Central Public Financial Institutions (CPFIs) and other government organisations.
  • So basically, this ETF will have a basket of bonds issued by CPSE, CPSU, CPFI or other government organization. And as per initially available information, all these bonds would be AAA-rated bonds.
  • But unlike Equity ETFs, the Debt ETF does not give investors the ownership of companies. Instead, it gives state-owned companies an option to borrow funds from investors. The Debt ETF collects the money from ETF investors and lends it to the companies that require the funds for a fixed period of time. The companies pay back money to the ETF (issuer), which in turn gives the amount back to the investors. So this is exactly what is meant by the Bond ETF being a new source of funding for these companies.

What is the Structure of Bharat Bond ETF?

Bharat Bond ETF will, in a way, function like a typical Close-Ended Fund or FMP. It will always have a fixed maturity date. Also, each series of Bond ETF (there will be two initially) will have an index and the ETF will only be tracking that index.

And since ETF is a passive product which replicates an index; there will be no active selection by a fund manager. So basically for investors, they are giving up the chance to outperform the index but in return, they are getting ETF structure which comes with super lower costs.

As of now, the Bharat Bond ETF will have 2 maturity series with defined maturity periods of 3 and 10 years.

  • Bharat Bond ETF for 2023 (with 3-year maturity)
  • Bharat Bond ETF for 2030 (with 10-year maturity)

These 2 bond ETF series will expire in the above-mentioned respective years. Bond ETFs which come with a defined maturity like Bharat Bond ETF are popularly known as Target Maturity ETFs in other countries.

And it is highly likely, that the ETF managing AMC will keep launching new series (2 tranches) every year to create a ladder of Bond ETFs maturing every year.

So after the launch of Bharat ETF 2023 with 3-year maturity, we may see launch of Bharat Bond ETF 2024 (to be launched in 2021 with 3-year maturity), Bharat Bond ETF 2025 (to be launched in 2022 with 3-year maturity), Bharat Bond ETF 2026 (to be launched in 2023 with 3-year maturity). Similarly after the launch of Bharat ETF 2030 with 10-year maturity, in later years we may see the launch of Bharat Bond ETF 2031 (to be launched in 2021 with 10-year maturity), Bharat Bond ETF 2032 (to be launched in 2022 with 10-year maturity), Bharat Bond ETF 2033 (to be launched in 2023 with 10-year maturity) and so on.

After a few years, there will come a time when each year will have a few Bond ETFs ready to mature.

Now coming back to 2 series of Bharat Bond ETF about to be launched.

You can invest in these ETFs with a minimum of Rs 1,000. This low ticket size Rs 1,000 for Bharat Bond ETF will no doubt provide a better opportunity to retail investors for participation in the corporate debt market with low credit risk. And the cost structure of just 0.0005% does indeed make Bharat Bond ETF one of the cheapest investment options available.

And how can we be sure about the low credit risk in Bharat Bond ETF?

Because this ETF is made up of bonds issued by government organizations and hence, the credit risk is comparatively very low (if not zero).

If you wish to know which are the actual government companies whose bonds will be part of the ETF, then here is your answer – As per the data available online, both the series will track separate indices. And the constituents are as follows:

The 3-year Bharat Bond ETF mirrors Nifty BHARAT Bond Index April 2023 constituents. These 13 constituents are:

  1. REC Ltd – AAA rated – 15.00%
  2. National Bank For Agriculture & Rural Development – AAA rated – 15.00%
  3. Power Finance Corp Ltd. – AAA rated – 15.00%
  4. Housing & Urban Development Corp. Ltd – AAA rated – 11.84%
  5. Export-Import Bank of India – AAA rated – 8.00%
  6. Power Grid Corp of India Ltd – AAA rated – 7.24%
  7. Small Industries Development Bank of India – AAA rated – 7.00%
  8. NTPC Ltd – AAA rated – 6.67%
  9. Hindustan Petroleum Corp. Ltd – AAA rated – 4.87%
  10. National Highways Authority of India – AAA rated – 3.85%
  11. Nuclear Power Corp. of India Ltd – AAA rated – 2.43%
  12. Indian Railway Finance Corp. Ltd – AAA rated – 1.88%
  13. NHPC Ltd – AAA rated – 1.21%

The 10-year ETF holds a slightly different portfolio.

The 10-year Bharat Bond ETF mirrors Nifty BHARAT Bond Index April 2030 constituents. These 12 constituents are:

  1. National Highways Authority of India – AAA rated – 15.00%
  2. Indian Railway Finance Corp. Ltd – AAA rated – 15.00%
  3. Power Grid Corp. of India Ltd – AAA rated – 15.00%
  4. REC Ltd – AAA rated – 12.72%
  5. NTPC Ltd – AAA rated – 11.63%
  6. Indian Oil Corp. Ltd – AAA rated – 8.00%
  7. Nuclear Power Corp of India Ltd – AAA rated – 6.61%
  8. Power Finance Corp Ltd – AAA rated – 6.51%
  9. NLC India Ltd – AAA rated – 3.93%
  10. Export-Import Bank of India – AAA rated – 2.84%
  11. National Bank For Agriculture & Rural Development – AAA rated – 1.48%
  12. NHPC Ltd – AAA rated – 1.27%

As per SEBI regulations, the exposure to each bond would be restricted to a maximum of 15% in both the indexes. By the way, these are current index constituents and not permanent ones. They (or weights) may change in future as there will be a quarterly rebalancing of index constituents.

So as is clearly evident from the constituents of Bharat Bond ETF, it will hold a well-diversified basket of bonds issued by central public sector enterprises/undertakings or any other government organization bonds to provide effective diversification. The first series of ETFs is going to hold only AAA-rated securities. But it’s possible that the later tranches could hold securities rated below AAA as well.

Upon maturity, the money will be paid back to investors. So if an investor remains invested for 3 years in Bharat Bond ETF 2023 and 10 years in Bharat Bond ETF 2030, then he will receive the money plus interest earned at the time of maturity.

By the way, Bharat Bond ETF will only offer growth option to investors. There would be no dividend option in these ETFs. And since there is no interest income from this ETF, its not suitable for investors looking for regular income from their debt (bond) investments.

Maturity is at the end of 3 and 10 years. But you can exit Bharat Bond ETF even before 3 or 10 years. The Bharat Bond ETF units will be listed on the stock exchanges. So the units are tradable on Indian stock exchanges and you can buy or sell units of this ETF on exchange anytime during the tenure of the fund. But there is another factor that needs to be discussed – how easy or tough it would be sell or buy ETF units on the exchange, as it will depend on the market depth created by the ETF management. I will discuss this aspect a little later in this post.

I mentioned earlier that the AMC will be launching two ETFs every year. So what would happen to the older tranches of Bharat Bond ETFs?

As per my understanding, the 3-year and 10-year tranches from older series will continue to be available for those who wish to buy shorter duration schemes. That is in addition to the availability of the units for sale/purchase on the exchanges. But if an investor wants to buy units of ETF midway through its tenure, then he would need to re-calculate the yields to understand how much returns they could potentially get from those units.

How much returns will Bharat Bond ETF give?

That’s not an easy question to answer.

And if you are looking for a nice surprise, then no there isn’t.

The returns of Bharat Bond ETF are not guaranteed (assured) as you get in government-guaranteed savings products like EPF, VPF or PPF.

The actual returns aren’t guaranteed and depend on a lot of factors. But being a product that comes with a defined maturity, it does give some indication. And since Bharat Bond ETF will invest in securities that are rated pretty high, you can say that returns would be more or less like those of comparable debt fund categories.

These ETFs will track the performance of the indices i.e. Nifty Bharat Bond Index-April 2023 (3-year ETF) and Nifty Bharat Bond Index-2030 (10-year ETF). And as of now, the data for these indices is as follows:

  • The indicative yield of Nifty Bharat Bond Index-April 2023 is 6.69% p.a.
  • The indicative yield of Nifty Bharat Bond Index-April 2030 is 7.58% p.a.

So you can expect returns in a similar range. Now compare this with EPF interest rates (latest & historical) and PPF interest rates (latest & historical) to get an idea about what’s actually being offered by these new ETFs. So even though Bharat Bond ETF is being pitched as a tax-efficient long term investment option for conservative debt fund investors, it cannot be ignored that you get higher guaranteed returns from provident funds.

But let’s be fair and let me remind that these are indicative yields of the index. Your actual returns on Bharat Bond ETF will be slightly different and depend on the interest rate cycle in which each ETF tranche gets launched and also the quality of underlying securities.

Assuming that the credit risk or default risk or downgrade risk is pretty low (as government entities are the bond issuers; though risk isn’t zero either), it can also be said that the interest rate risk in 3-year ETF would be lower than 10-year ETF as the longer duration variant (Bharat Bond ETF 10-years) would naturally take high duration risk.

But in any case, I think for the Bharat Bond ETF to really do well and serve its real purpose, having a basket of good-quality bonds is very important for the ETF. And to ensure some structure in keeping risks under control, the regulator SEBI has put in place some rules and guidelines for debt funds ETFs like Bharat Bond ETF. According to the new rules, the indices for these ETFs should have a minimum of eight issuers and the exposure of ETF to a single issuer is 15%. To know more about these rules, refer to this link on SEBI’s site.

(Important) Risk of Liquidity in Bharat Bond ETF

This is a very important aspect that should be paid attention to.

As you know, once you purchase the Bharat Bond ETF, if you wish to exit before 3 years or 10 years (depending on which maturity ETF you own), all you have to do is go to an exchange and sell it like any other stock is sold on the exchange.

But there is one problem here.

The question to be asked is whether there would be enough liquidity in the market for the Bharat Bond ETF’s units so that the investors are able to buy and sell easily without any unwarranted price movements?

Let’s take an example to understand this:

Suppose you have 10,000 units of Bharat Bond ETF which were purchased at (let’s say) NAV of Rs 10.00 each. Now the latest NAV is 11.00 after 1 year. That is, it’s up 10%. So now instead of waiting till maturity, you wish to sell 5000 units at the prevailing market price. Ideally, you want to sell at the current NAV of Rs 11.00. But since the units are listed on the exchange, you may not find a buyer who would want to buy this entire lot of 5000 units at Rs 11.00 each. What will happen then? You may find different buyers at different prices. So maybe 1000 units can be sold at Rs 11.00. But for selling remaining 4000 units, you may get lower and lower prices like Rs 10.85, Rs 10.73, Rs 10.65, etc. So for the remaining units, the price keeps fluctuating, depending on the demand order book for Bharat Bond ETF units on that particular stock exchange.

Because in the absence of sufficient trading volumes, the investors will end up buying or selling at a steep premium or discount to the prevailing NAV. And which is a big problem given the fact that bonds offer limited returns and upside potential. So if buy or sell price is impacted adversely due to lack of liquidity, then this is a big problem.

So to sum this problem up, sufficient market liquidity becomes important to sell your Bharat Bond ETF at a price at which you want (and close to its NAV). And keeping such costs low is very critical in bond ETFs, where upside in returns is limited relative to equity ETFs.

It would be very important that there is constant liquidity available in ETF units at low spreads. And this no doubt may be difficult in initial days but would be very important to have in later times. You don’t want to be in a situation where lack of liquidity results in 0.5% to 0.75% cut in your returns. Many equity ETF investors also face this problem where the difference between the ask and bid may go up to 1% at times.

But I think the AMC has confirmed that they will be appointing multiple market makers to ensure enough liquidity is available. If this is done, then it would result in healthy trading volumes for the ETF on the exchanges by market makers. And proper liquidity will allow bond ETF investor to fetch a purchase or sale price closer to the fair value of the ETF, as indicated by its net asset value (NAV).

This is a major risk with this and other ETFs and its too early to say how this will actually play out. It will be interesting to see how market makers help create the liquidity and whether a sufficient number of units are made available to those who wish to buy them, as well as for buying from those who wish to sell some units.

I am sure that atleast initially, the fund house will do whatever is required to ensure proper liquidity of Bharat Bond ETF to make it successful. But this will be clear only later on.

So after the initial NFO days are over for Bharat Bond ETF, and if you wish to invest in Bharat Bond ETF, you can do it in 3 ways

  • Through Indian exchanges during trading hours.
  • Through AMCs (but only for very large investors having appetite for Rs 25 Cr +)
  • Through market makers where they will keep an inventory of units and be in a position to buy/sell ETF units.

Taxation of Bharat Bond ETF (Capital Gains): 2019-2020

The taxation of gains arising from Bharat Bond ETF would be similar to the taxation of Debt Mutual Funds in India:

  • If you sell Bharat Bond ETF before 3 years, then the capital gains will be considered as Short Term Capital Gains and the STCG Tax on Bharat Bond ETF will be as per your income tax slab.
  • If you sell Bharat Bond ETF after 3 years, then the capital gains will be considered as Long Term Capital Gains and the LTCG Tax on Bharat Bond ETF will be as 20% with indexation benefit.

If you don’t know about indexation, then for your knowledge, it is the process of adjusting the purchase price of an investment for inflation, which helps bring down the quantum of capital gains, thereby reducing the capital gains tax on it. You can read more about it at Using Indexation to lower Long Term Capital Gains Tax and also read the basis of this, which is how Cost Inflation Index (CII) numbers are used for indexation calculations.

So from a taxation perspective if you remain invested for more than 3 years, then Bharat Bond ETF would be more tax-efficient than a bank fixed deposit where the interest earned is added to your income every year and taxed as per applicable tax slab rate

Is Demat Account required to Invest in Bharat Bond ETF?

Yes. To invest in Bharat Bond ETF (since you can buy and sell only via stock exchanges), you need to have a Demat account.

But if you don’t have a Demat account and also, don’t want to have one, then you have another option.

The AMC handling the Bharat Bond ETF you offer Fund-of-Funds (FoF) options. These FoFs will invest in the Bharat Bond ETF by collecting money from investors the way normal mutual funds do and then invest its 100% entire proceeds of the fund portfolio in the Bharat Bond ETF.

But since there is a layer of FoF between you and the actual ETF, it will increase the expenses. So the like all other mutual funds, the expense ratio of FoF will be an additional burden on those looking to invest in ETF via FoF route. But it will still be very low (much lower than mutual funds) as per my understanding.

There will be 2 Fund-of-Funds for investing in the two series of ETFs:

  1. BHARAT Bond FOF (April 2023) which has the stated investment objective ‘To generate returns by investing in units of BHARATBondETF – April 2023’ and will be benchmarked against Nifty BHARAT Bond Index (April 2023)
  2. BHARAT Bond FOF (April 2030) which has the stated investment objective ‘To generate returns by investing in units of BHARATBondETF – April 2030’ and will be benchmarked against Nifty BHARAT Bond Index (April 2030).

Conclusion

So that was all that I had to share about the new debt investment vehicle called Bharat Bond ETF.

The biggest attraction for investors here is the low expense ration (its an ETF and hence will always have low expenses) and the low risk of this offering due to the credit quality (as it invests only in Government-backed entities having AAA rating).

And no doubt that since it follows a low-cost ETF structure and invests in low to nil credit risk bonds of government-backed entities, this is a product with potential. Think of it as a part of a very simple portfolio holding Equity Index ETF and this being the debt part via Bharat Bond ETF. Not bad an option for an ultra-simple investor. Isn’t it?

Till now, retail investors had very little access to the bond market. For the debt portfolio, most investors just had various categories of debt mutual funds: which continue to be a very decent route to invest in the Indian debt markets.

Then there are every popular Public Provident Fund, tax-free bonds, low equity Conservative Life Cycle Fund of NPS, etc.

This newly launched Bharat Bond ETF is definitely good for the market. But whether it is good for you as an investor depends on your requirements. You cannot invest in random products, even if it is an attractive and exciting new product.

At the end of the day, what works best for most people is to follow Goal-based Investing and invest in accordance with their goal requirements.

And once goals are clear, following a proper asset allocation is the most important thing. This can be easily achieved if you have a well-thought-out Financial Plan made by a Good Advisor in front of you.

There is a lot of potential for products like debt ETF (more so in coming years). But remember, that being an ETF, the low cost and overall consistency in performance will be the main reasons why investors would look to allocate funds to this Bharat Bond ETF or any other debt ETF in the long run.

If you want better than Fixed Deposit returns and want to keep thing simple, debt mutual funds are still a good option. Long term savings products like EPF (Employee Provident Fund), PPF (Public Provident Fund), NPS (National Pension System) and tax-free bonds can also be part of your overall long term debt exposure (though debt funds can also play that role efficiently).

But when it comes to Bond ETFs, it’s too early to say how best it would fit in an investors portfolio.

No doubt it’s a good product which may be suitable for many investors seeking low risk, predictable returns and a reasonable level of liquidity. But it’s not necessary for everyone to make space for it in their portfolios and invest in the Bond ETF just because there is a lot of noise around it.

So stay calm and think carefully before you decide to invest in Bharat Bond ETF in 2020. If you are not sure how this new ETF can fit into your overall portfolio, its best to get in touch with an investment advisor to get proper advice.

Note – Bharat Bond ETF is a product which is recently launched and details are still coming slowly. This is my view as per the publically available data. I may change my view going forward once I have a look at finer details of the product when it is actually launched. I will update the post accordingly (if need be).

One comment

  1. Not only the risk of not getting the NAV when someone wants to sell in the market, but, also, that since you cannot trade in the market without an intermediary/broker, therefore brokerage charges along with STT, exchange turnover tax and other such charges would be applicable which will make up roughly 0.60 to 0.70% of the traded value. This will erode the basic purpose of such ETFs. Every trade would erode my value by 0.60 to 0.70%.

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