Understanding Bharat Bond ETF as an Investment option in India: On Dec 4, 2019, Finance Minister Nirmala Sitharaman announced the formation of India’s first Bond Exchange-Traded Fund (ETF). This first corporate bond ETF of the country was named ‘Bharat Bond ETF’. This news came nearly two years after the then FM Arun Jaitley announced a plan to launch a bond ETF in his 2018 -19 budget speech.
The FM Nirmala Sitharaman announced that this move was in order to deepen Indian bond markets and at the same time provide additional money for Public sector units. Today, we try and decode what these funds newly introduced in the Indian markets really are.
Before we look into what a Bond ETF is it is actually better to look into bonds and ETF’s separately so as to understand them better.
A Bond is a financial instrument used by a company to raise funds from the stock market. Here, the investors are paid interest in exchange for the amount lent to the company. It is safe to say that bonds are a means of raising debt. Here the periodical interest is paid to the investor and the principal amount is repaid on maturity. A bond does not give any ownership right to the investor but there exists a risk of default on the loan.
An Exchange Traded Fund(ETF) is a fund that is actively traded on the stock market. If you have noticed mutual funds, on the other hand, do not trade in the stock market. An investor who wishes to invest in a mutual fund does so based on a previous day’s calculated Net Asset Value(NAV) price. In the case of these mutual funds the demand and supply forces of the stock market do not influence the fund price directly and neither can they be bought and sold through the stock market.
An ETF removes this inconvenience faced by the fund. This is because ETFs are the answer for funds that hold different types of securities to be traded on the stock exchange. This is made possible in ETFs through an arbitrage mechanism to keep the prices on the stock exchange close to the funds’ NAV.
In Bond ETFs, a fund is created that invests only in bonds and at the same time, it is made available to investors through the stock market. Bharat Bond ETF does the same while investing only in public sector bonds.
How does Bharat Bond ETF work?
Bharat Bond ETF offers a portfolio to its investors which only includes public sector bonds that have a ‘AAA’ credit rating. Bharat Bond ETF offers investors two products. A BBETF maturing in 3 years and another maturing in 10 years. The main aims of the ETF are realized due to their ability to be accessed by small retail investors. The Bharat Bond ETF allows a minimum investment amount of Rs.1000.
An investor who would otherwise choose to invest in bonds directly would require investments of significantly higher amounts. The ETFs allow a maximum investment Rs. 200,000. The ETF functions as a growth model. Here the returns that are earned on the investments in the fund are reinvested. This adds to the benefits of compounding.
Why are the benefits of BBETF?
Investing in the newly introduced Bharat Bond ETF offers the following benefits:
— Reduced Investment size
Generally, when an investor would want to invest in the bond market he would be required to make a significantly higher investment. A retail investor would find this amount to be too much to be invested in one company alone.
Tuhin Kanta Pandey, the secretary of Dept. of Investment and Public Asset Mgmt.) highlighted that prior to Bharat Bond ETF retail investors would have no means of accessing bond markets as bond issuances would be done through private placements. The amounts required to be raised here was Rs 10 lakhs.
What BBETF does is it provides investors with the option to invest with a minimum sum of Rs. 1000.
— Benefits of diversification
BBETF offers its investors the benefits of diversification. The investors receive these benefits as the ETF invests in multiple bonds. This protects the investors if a few of the investments fail as the investments that perform well set off the losses.
As the Bharat Bond ETF trades in the stock market, it offers its investors liquidity as they can be bought and sold accordingly.
— Taxation Benefits
Investments in Bonds that are held for more than 3 years receive an indexation benefit. The Bharat Bond ETF also offers the benefits of indexation. Through indexation, the tax imposed on the investors will be adjusted to the amount of inflation.
— Portfolio Quality
BBETF invests only in funds that are graded as ‘AAA’ securities. ‘AAA’ is the highest rating issued to a bond by a credit rating agency. These ratings are issued based on the issuer’s ability to meet its financial requirements and at the same time have a low risk of default.
— Projected Returns
Following were the projected Yield offered by the two Bharat Bond ETFs
- BHARAT Bond ETF April 2023 – 6.7%
- BHARAT Bond ETF April 2030 – 7.6%
The post-tax yield after the indexation benefits are considered to stand at 6.3% and 7% for the 3 years and 10-year bonds respectively. These returns are estimates and not guaranteed. They will vary depending on the market conditions and interest rates.
Who manages the BBETF?
Edelweiss was selected as the Bharat Bond ETF in its first tranche. Bharat Bond ETF has been dubbed as the world’s cheapest fund. This was because BBETF runs at almost zero cost at a 0.0005% charge per annum on the investments. This means that an investment of Rs 200,000 would have a charge of Rs. 1 per year.
Where does the BBETF invest in?
Each of the 2 BBETF products follows separate independently created indexes. The index is constructed with the help of the NSE. These indexes involve only ‘AAA’ rated stocks of public companies. The indexes are rebalanced on a quarterly basis. The maximum exposure given to a bond in the index is 15%.
Is the BBETF without any risk?
The Bharat Bond ETF is not free from risks. They include the innate risks that come with bonds.
The interest offered by a bond will remain constant until maturity. The price of a particular bond reacts on the basis of interest offered by other bond securities.
Say a year after bond ‘A’ is issued the other newly issued bonds in the marked start offering higher interest rates. This will lead to investors selling bonds ‘A’ as they would look for the higher returns from other bonds. This creates a situation where there is reduced demand for bond ‘A’ hence reducing its price.
How can I invest in BBETF?
Bharat Bond ETF is available to investors through two routes
— New Fund Offering (NFO)
An investor has the option of investing in a BBETF at the New Fund Offering. This is made available to investors twice in a year as BBETF is launched every 6 months.
— Fund of Funds (FOF)
Investors are also given the option of investing in the ETF through a FOF. This will be available to the investors throughout its tenure. The FOF also offers the investors to opt for SIP. Investors are not required to have a DEMAT account to invest via the FOF. The investor simply can do so through https://bharatbond.in/.
It should be noted that choosing the FOF route results in the increased cost charged. The added expenses of the FOF bring the cost of investment to 0.0515%.
Is there a lock-in period?
Bharat Bond ETF’s do not have a lock-in period. But they do however have an Exit load in the case of a FOF. An exit load of 0.10% is charged if an investment is withdrawn with 30 days. There is no exit load charged if the investment is withdrawn past the 30-day mark.
Bharat Bond ETF as an investment option?
Bharat Bond ETF was welcomed in the Indian markets with 1.7 times subscription. After raising Rs. 12,400 crore in its initial investment the ETF is now preparing for its second tranche. Edelweiss announced that the second tranche will take place in July for the two series maturing in 2025 and 2031.
The covid19 environment has disrupted the investment behavior of investors. Investors are now more risk-averse and look for the safety of their investments. This environment has made fixed schemes like the Bharat Bond ETF more attractive to investors. This can be owed to the mix of tax benefits, low cost, returns, liquidity, and security offered by the Bharat Bond ETF.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.