The government of India’s much awaited Bharat Bond Exchange Traded Fund (ETF) is now open for subscription for retail investors till December 20, 2019.
Launched by Edelweiss Mutual Fund, the bonds can be accessed by investors via the ETF and fund of fund (FOF) route, for those who don’t have a demat account. Retail investors can invest up Rs 2 lakh in these funds.
Both variants - Bharat Bond ETF April 2023 and Bharat Bond ETF April 2030 will invest in AAA rated bonds of Central Public Sector Enterprises and other government organizations and will be listed on exchanges for facilitating liquidity. What works in its favour is its lowest cost and indexation benefit. Let’s take a look at whether it is worth investing in these ETFs.
Portfolio
The fund will predominantly invest in the constituents of Nifty Bharat Bond Index. Akin to FMP, the ETF/FOF will invest in bonds maturing along with the fund. However, this ETF/FOF is open end, which allows investors to buy and sell till the scheme maturity while FMPs are closed end and often have thin liquidity. The fund may invest up to 5% in G-Sec / CBLO for liquidity management. Issuer weights are capped at 15%. Any issuer that ceases to be a CPSE, CPFI or statutory body or the rating is downgraded below AAA, the issuer will be removed from the index on the next rebalancing date.
Exit Load
While the ETFs will have no exit loads, those investing through the fund of fund route would be subject to an exit load of 0.10% if they exit before 30 days. Unlike open end debt funds, these ETFs have a target maturity which is denoted by their names.
Risks
Investors who hold the ETF till maturity will have reduced interest rate risk. However, if you redeem before maturity, price risk will remain. If the yields on the underlying bonds increase, the bond prices will fall, affecting the net asset value of the ETF/FOF.
Another important aspect one should take into account is liquidity. Lower liquidity can make it difficult for investors to exit the ETF, forcing them to redeem at discount on exchanges. One indication of lower liquidity is the bid ask spread. Wider the bid ask spread, lower the liquidity and vice versa. Edelweiss Mutual Fund states that they will be appointing multiple market makers who will intervene on the exchange by providing bid ask quotes at narrow margins and these market makers will hold adequate inventory to facilitate liquidity.
Expense Ratio
The expense ratio of FOF will be around five basis point both in regular and direct plans. The ETF will charge 0.0005% for AUM up to Rs 10,000 crore. The expense ratio goes down as the scheme AUM increases. For instance, 0.0004% per annum for the next 10,000 crore to 20,000 crore and 0.0001% for over Rs 20,000 crore.
Yield
The current yield of these indices are 6.69% maturing in April 2023 and 7.58% maturing in April 2030. Though the bonds are quasi sovereign, investors should note that the bonds do not provide capital protection or guaranteed return. Also, unlike FMPs where yields are usually locked in, the yields in this ETF can vary depending on market conditions.
Tax Benefit
If you hold your investments for more than 3 years, in ETF or FOF, it will qualify for long term capital gains (LTCG) with indexation like any other bond investments. Long term capital gains are taxed at 20% with indexation, which helps reduce the tax outgo. In comparison, interest income on deposits attract marginal rate of tax (can be 30% if you are in highest bracket). For instance, Rs 1 lakh invested in a traditional investment like bank deposit for three years assuming a yield of 6.69% will fetch post tax return of 4.79% versus 6.31% for Bharat Bond ETF (April 2023). Assuming bank deposit taxed at 30% and Bharat Bond ETF Taxed at 20% post indexation.
Our Take
Kaustubh Belapurkar, Director – Manager Research, Morningstar Investment Advisers India, says it is a good option for investors who are looking to invest in a high-quality fixed income portfolio given the mandate of the fund to invest purely in AAA rated PSU bonds. “Investors can minimize interest rate risk if they stay invested till maturity for which they have two options 2023 and 2030 maturity. The low expense ratio makes it an attractive option for investors looking for such investments. One thing that we will need to see is the liquidity that will be available on the ETF if investors wish to transact prior to maturity, otherwise the Fund of Fund option is a good alternative as the expense on this is also very attractive.”
ETF or FOF?
Should you invest in ETF or FOF? Manoj Nagpal of Outlook Asia Capital in this Twitter thread recommends investors to take the FOF option as liquidity is guaranteed by the fund house at the NAV because in the ETF route, it depends on the market and there will be risk of selling at discount. Should you invest in the fund purely due to its low cost? “Earlier due to tax benefits, many used to “invest” in Life Insurance products. Don’t make similar mistake by now putting cost ahead of your needs. Choose a product based on your need. Cost decision is later,” says Manoj.
