Home/ Money / Personal Finance/  What the two new Bharat Bond ETF NFOs mean for subscribers

Edelweiss Asset Management has announced the launch of two new Bharat Bond exchange-traded funds (ETFs). One will mature after five years in 2025 and the other after 11 years in 2031. Bharat Bond ETFs invest exclusively in AAA-rated papers of public sector companies.

Edelweiss AMC first launched two Bharat Bond ETFs, maturing in 2023 and 2030, in December 2019. According to data from Value Research, as of 31 May, the two ETFs have delivered returns of 6.84% and 8.6%, respectively, from the date of launch to 1 July. A part of the returns can be attributed to the repeated rate cuts by the Reserve Bank of India (RBI), which lowered bond yields and increased bond prices.

The new ETFs

The new fund offers (NFOs) will run from 14 to 17 July but you can invest in them later too since they are open-ended schemes. The Bharat Bond ETFs launched in December 2019 continue to trade in the market. The expense ratio for Bharat Bond ETFs is capped at 0.0005%. Other active debt funds, typically, have it in the 0.1-0.5% range, even for low-cost direct plans. The two Bharat Bond ETFs are mandated to track the Bharat Bond indices which consist exclusively of PSUs. The indices that the new five-year and 11-year ETFs track have yields of 5.72% and 6.79%, respectively, as on 1 July.

According to Edelweiss AMC, the 2025 Bharat Bond Index consists of 12 companies. The top four, which account for 56% of the index, are Power Finance Corp., REC Ltd, Power Grid Corporation of India Ltd and National Housing Bank. The 2031 Index consists of eight PSUs with the top four—Power Finance, REC, Power Grid and National Highways Authority of India (NHAI)—accounting for 60% of the index.

A few technical snags cropped up in the previous variants. Supply of PSU bonds was slow, forcing the ETFs to hang on to cash (or equivalents) for a while which ate into returns (read).

If you do not have demat and trading accounts and don’t want to take the risk of illiquidity in the ETF, you can also buy fund-of-funds (FoFs) that track these ETFs.

How they work

Bharat Bond ETFs follow roll-down maturity, which means that the maturity of its portfolio decreases as the ETFs approach their target dates. Broadly, if the 2025 ETF has a maturity of five years today, it will become four years in 2021, three years in 2022 and so on. This structure reduces interest rate risk—the risk that bond prices fall when interest rates go up.

To take a simplified example, a traditional debt fund with a maturity of three to five years will keep buying bonds of around this tenor when old bonds expire. So if interest rates rise, investors will suffer no matter how long they have held the fund. A roll-down fund, on the other hand, will see its maturity progressively decline and investors who’ve stayed for the long term will see lower risk of rate hikes.

How they stack up

By investing only in PSUs, Bharat Bond ETFs minimize credit risk, which debt funds have been grappling with in the past two years.

By following a roll-down maturity structure, they also reduce interest rate risk. However, interest rates are at historic lows and financial planners are not confident that they will remain so. If rates rise, investors locked into the ETFs may lose out.

Also, PSU yields are lower than those of AAA-rated corporate bonds which corporate bond funds capture. “Overall I still feel the AAA corporate bonds may give higher returns but those who prefer more safety and have a three-five years’ horizon can look at Bharat Bonds," said Rushabh Desai, a Mumbai-based financial planner.

Note that interest rate risk will affect those who can’t hold till maturity. The ETF’s net asset value (NAV) will fluctuate depending on the prevailing interest rates. The return predictability, which is a principle feature, will be lost if you don’t hold to maturity.

Some financial planners like Bharat Bond ETFs, including the long-dated variant. “You should invest in the newer 2031 ETF during the NFO to maximize yield. The 2030 ETF yield is similar. However, since there is usually a difference between the NAV and the price of the ETF, buying the older 2030 version can be more inefficient," said Anand K. Rathi, founder, Augment Capital Advisors LLP.

“The launch comes at a good time as the need for a product with high safety, predictability of return and liquidity is paramount. This (five-year variant) is a great product for core debt allocation, especially for hold-to-maturity investors. The combination of return predictability with tax efficiency, the safety of AAA CPSEs, and low cost make it an exciting launch. Liquidity conditions have also been well tested since the first launch," said Radhika Gupta, managing director and CEO, Edelweiss AMC.

ETFs also enjoy a tax advantage over other saving products such as bank fixed deposits or the 7.15% taxable bonds. This is because capital gains in the ETFs are taxed at 20% with the benefit of indexation if they are held for more than three years. An illustration by Edelweiss AMC shows an effective tax rate of 4.18%, assuming six years of indexation, for the 2025 ETF. Interest from bank FDs is taxed at the slab rate which could be as high as 30%.

Investors seeking a defined yield at low risk will find value in the Bharat Bond ETFs but they should be prepared to hold till maturity. But they should ensure other products in their portfolios are geared up for inflation.

Neil Borate
Neil heads the personal finance team at Mint. A former colleague called them 'money nerds' and that's what they are. They cover topics like mutual funds, taxation and retirement, all to improve your chances of building wealth. Neil graduated with a degree in law and economics. He passed the CFA Level I exam and began his writing career at Value Research, a mutual fund research firm in 2016. He joined the personal finance team Mint in 2019. Everyday, the Mint Money Team tackles personal finance questions such as where to invest and where to borrow, through articles, charts and reader queries. They also have a daily podcast - 'Why Not Mint Money' and an annual ranking of mutual funds - the Mint 20.
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Updated: 09 Jul 2020, 07:04 PM IST
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