Please note that the details of the PSU Debt ETF mentioned here are based on reports. There is no official document on the Nifty Bharat Bond index or the Bharat Bond ETF from Edelweiss MF. The idea of this article is to highlight an emerging investment class and its contours based on reported information available.

Owning bonds, unless you are well-diversified, has become a super risky proposition since September 2018. Credit risk and drying up of liquidity have proved to be lethal combinations to manage for investors.

Outside of debt funds, your options to hold a basket of fixed-income instruments are limited. Today, if you want to invest in debt ETFs, you have just 2 options. One is liquid ETFs. The other is gilt ETFs – based on the 10-year G-Sec index and on the 8-13-year G-Sec index. While liquid ETFs have volumes, their return appeal is limited. Gilt ETFs are yet to pick up in volumes and carry volatility and rate risk.

However, when the government decides to make things happen, it can. The ETF space in India turned a little more vibrant with the launch of CPSE and Bharat 22 indices and ETFs based on them.

Now the debt ETF space may receive some life with the soon-to-be launched defined maturity PSU Debt ETF.

Deposits, bonds, funds and FMPs

Let’s look at the typical options for you in debt today, before we go to the proposed ETF.

When you hold deposits, you have a fixed interest rate and fixed maturity. However, you can’t sell your deposits midway. You may have to pay a penalty if you break the deposit. Also, there is the risk of the bank or company not being able to repay you.

Now take a bond. Bonds typically offer higher interest rates than fixed deposits. When you hold a bond there is certainty of a fixed interest and a maturity date. You have the leeway to sell it midway (provided there are takers for the bonds in the market) if you need the money. This may be at a loss or gain depending on the interest rate cycle. However, if you just hold 1 or 2 bonds, you are placing all your eggs in one basket. You run a credit and concentration risk unless you sufficiently diversify, which may be hard to do.

Next consider open-ended bond fund from a mutual fund house. In a bond fund,  you hold a large basket of several bonds with varying interest ad varying maturities. The fund by itself doesn’t have a maturity. The fund will hold instruments that mature or are sold but are always replaced with other bonds. This will be an on-going process.

But since there is no maturity and the underlying instruments are not fixed, you don’t know the interest rate or tenure for certain; i.e., you are left to wonder what your return could be.. If you align your investment to the maturity of the fund at the time of your investment, chances are, you will get the yield sported by the fund at the time of your entry. The positive aspect is that you can sell when you need the money. They are more tax efficient than deposits if held for over 3 years.

 Fixed maturity plans or FMPs from mutual funds are a kind of mid-path between bonds and an open-ended bond fund. FMPs simply buy and hold instruments whose maturities are the same as that of the FMP. In other words, if you held several bonds and held them till their maturity, that would be like an FMP, in a simplified way. Here, you get a little more certainty on the returns because you know the same instruments are going to be held till the FMP matures. It is also tax efficient as capital gains benefits are available for over 3-year periods.

Both FMPs and bond funds still carry credit risk although the diversification reduces it as opposed to holding individual bonds.

A maturing ETF

Now, the above investment options have some limitations or the other. Those that offer you fixed interest and maturity do not provide liquidity (deposit, FMP) or have higher risk (bond) unless diversified. Those that are well diversified (bond fund) and offer liquidity do not provide certainty of return. This is where a defined-maturity ETF can fit.

A defined maturity ETF will be a basket of debt instruments with a fixed date of maturity. Its instruments will be bought and held till maturity. The ETF will be traded on the exchange to provide you with an exit, when you want, before the maturity date. You can also buy them on the exchange after the NFO. Since the instruments don’t change, you will know that the returns you will get will roughly be the interest or yield of the underlying instruments, if you hold them through the tenure. These ETFs will be taxed like debt funds, enjoying capital gain indexation benefit if held for over 3 years.

This kind of ETF is very similar to an FMP, except that it is expected to be more liquid.