Bharat Bond ETF

By: Tavaga Research

• The first series of the Bharat Bond ETF was launched in December 2019 with 2 ETFs maturing in 3 years (April 2023) and 10 years (April 2030) respectively.
• The 2^nd tranche will be offering maturities of 5 years (Bharat Bond April 2025) and 11 years (Bharat Bond April 2031) respectively.

Bharat Bond ETF is an initiative of the Government of India launched by the Edelweiss Asset Management Company. After a good successful launch of the 1^st tranche in December 2019, the NFO (New Fund Offer) for the 2^nd tranche is now open for subscription, from 14th July 2020, and will close on 17th July 2020. The 2^nd series of the Bharat Bond ETF aims to garner Rs 14000 crore with a minimum investment of Rs 1,000 and a maximum limit of Rs 2,00,000 for retail investors. The non-institutional investors and the QIBs can invest a minimum of Rs 2,01,000 and in multiples of Rs 1,000 thereafter. The money collected through the ETFs will be invested in AAA-rated public sector company bonds with the Government of India holding more than 51%.

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What exactly is the Difference between the Bharat Bond ETF and The Bharat Bond FoF?

1. Bharat Bond ETF is a passive product that tracks the Nifty Bharat Bond Index created by the National Stock Exchange (NSE). Being an ETF, it trades on an exchange and hence, only the investors having a demat account are eligible to subscribe.
2. The Bharat Bond FoF is a fund of funds scheme which invests in the units of Bharat Bond ETF. A demat account is not necessary for investors wishing to apply through the FoF route.

Why is it disadvantageous for an investor to not include the Bharat Bond ETF in the Portfolio?

• Bharat Bond ETF is a mixture of bonds, mutual funds, and ETFs. It is structured like a bond as the returns are predictable, it has a fixed maturity and there is a lower interest rate risk if held till maturity. With a fixed maturity structure, the returns are close to the indicative yield at the time of investment. Unlike an NCD, where there is a single security risk, the Bharat Bond ETF offers a diversified portfolio and is professionally managed like mutual funds. Being an ETF, it is transparent and a low-cost product
• As the Bharat Bond ETF invests in AAA-rated government companies, there is minimal credit risk and thus offers safety to its investors
• There is no lock-in period. Once purchased, there is no restriction on the sale of the unit during trading hours
• Bharat Bond ETF is a tax-efficient product as the investor gets the benefit of indexation at the time of maturity
• Unlike Mutual funds whose NAV is updated at the end of the day, Bharat Bond ETFs price is live throughout the day Also, there is a daily disclosure of portfolio constituents of the ETF which brings in a lot of transparency
• With an expense ratio of 0.0005%, the Bharat Bond ETF is one of the cheapest debt instruments available in India

How was the response to the first series of the Bharat Bond ETF and how has it performed?

The market participants not only responded well to the 3-year bond but also the 10-year bond.

What’s interesting is the size of the AUM of the long term (10-year maturity) bond ETF which has nearly doubled. This is in a period where, traditionally in India, there is not much money invested in the long duration bonds (60-70% of the long term debt AUM is typically under 2 years). Also, it is important to note that this has come at a time when the debt market has been under tremendous stress. 

Takeaways:

1. While the HNIs preferred the 10 year ETF, the banks and other financial institutions equally contributed in both (3 years and 10 years) the ETFs.
2. The retail category’s participation was very low with a contribution of 0.5% of the total.

The past performance of these ETFs has been phenomenal, however, the interest rates have also reduced drastically during this period and hence, the above returns should not be used as proxies for the 2^nd tranche. The indicative yield of 5.6% should be considered for the Bharat Bond ETF – April 2025 and 6.75% for the Bharat Bond ETF – April 2031 (Indicative yields as of 6^th July 2020).

1-year Performance of Bharat Bond ETF – April 2030

How is the Nifty Bharat Bond Index constructed?

1. Selection: The AAA-rated bonds issued by the public sector companies maturing within 12 months before the maturity of the index are selected.
2. Assigning weights: Larger borrowers having liquidity in the market get higher weightage (single company exposure is capped at 15%).
3. Rebalancing: Constituents of the index are rebalanced every quarter.

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What can go wrong with the Bharat Bond ETF?

• Tracking difference and Tracking Error: Tracking difference (the difference between the index return and the fund return) and tracking error (standard deviation of tracking difference) must be as low as possible, failing which an investor bears the cost

How to apply for the Bharat Bond ETF NFO?

1. For the Bharat Bond ETF scheme, investors can apply online through the stockbroker for which a demat account is necessary. The investor can also subscribe to the ETF by applying directly to the AMC by filling the application form available on https://www.bharatbond.in/
2. Investors who don’t have a demat account can apply through the Bharat bond FoF route

Liquidity of Bharat Bond ETF:

Post the launch of the first Bharat Bond ETF series, all the doubts concerning liquidity were put to rest as the market makers and the AMC itself have done a good job. The average daily trading volume of the ETF is between Rs 3.2 crore to 3.7 crore which is significantly higher than the G-Sec ETFs whose average daily trading volume is between Rs 1 lakh – Rs 2 lakh. The average bid-ask spread has been around 5-10 bps at a time when the overall bond market liquidity was very low. Lately, the investor sentiment has improved because of the rate cuts by the RBI. The central bank has not only reduced the repo rate but also pumped in a lot of liquidity by doing Open Market Operations (OMOs). The bond market participants expect no less from the RBI in the 2^nd half of 2020-21 and this should surely help the upcoming Bharat Bond ETFs.

Product-related FAQs:

• How can I get Bharat Bond ETF?

Bharat bond ETF can be purchased during the New Fund Offer (NFO) period through a stockbroker or one can buy or sell during trading hours on NSE or BSE once the bond gets listed (Demat account is mandatory).

• Is Bharat Bond ETF tax-free?

No, the long term capital gains (if held more than 3 years) from the Bharat bond ETF are taxable at 20% post indexation. Indexation leads to a reduction in net tax payable as the returns are adjusted for inflation. If the ETF units are sold before the 3-year holding period, short term capital gains would be added to investor’s total income and taxed without any indexation benefit.

• Can NRI invest in Bharat Bond ETF?

Yes, NRIs can invest in the Bharat bond ETF through the broking account.

• What is the fixed maturity series of the Bharat Bond ETF?

Bharat bond ETF has a target maturity structure, meaning, the ETF has a fixed term and the portfolio holds bonds that match the maturity of the Bharat bond ETF. The 2^nd tranche of the Bharat bond ETF will invest in two fixed maturity periods of 5 years (April 2025) and 11 years (April 2031) respectively.

• Can bond ETFs lose money?

Yes, one can incur a loss by investing in a bond ETF. The price and interest rates have an inverse relationship. Therefore, if interest rates rise, the price of bonds may fall and by selling the bond ETFs at a price below the initial investment, one can make a loss.