Festival offer expires in

Days
Hours
Minutes
Seconds

Grab the offer now!

Our once-a-year festival offer expires in

Days
Hours
Minutes
Seconds

Hurry up and grab the offer now!

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

Letā€™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 canā€™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, Ā you hold a large basket of several bonds with varying interest ad varying maturities. The fund by itself doesnā€™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 donā€™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.

Ā 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 donā€™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.

The Bharat PSU ETF

Edelweiss has filed for a defined maturity ETF that will invest in AAA-rated PSU bonds with a fixed maturity. This will be Indiaā€™s first maturing ETF as the current gilt ETFs do not have a defined tenure. The ETFs are expected to come in 2 maturity buckets – 2023 and in 2030. As and when they mature, newer ETFs with different maturities may be issued.

This ETF will stand out for several reasons:

  • One, it is an ETF that matures. Hence you reduce market risk if you hold the ETF till maturity. You will get the principal plus the interest (that is reinvested as and when received) at the end of the tenure.
  • Two, it is widely expected that they will be liquid enough (as was the case with PSU equity ETFs) as the government will push for retail participation, besides generating institutional interest.
  • Three, since these will be PSU bonds, the credit risk will be almost nil as PSUs are government backed and liquidity risks may also be limited.
  • Four and very importantly, the ETF cost is expected to be so low that a well-managed bond fund with just an all PSU portfolio may find it hard to beat this ETF, post expenses.

However, wherever there is a maturity, there is a reinvestment risk – the risk that you may get a lower interest rate if you reinvest your money after maturity. While there are strategies to overcome this if you hold a series of ETFs with different maturities (like mutual funds do by holding bonds with varied maturities), the safest way to avoid reinvestment risk is if your own goal is aligned to the ETFā€™s maturity.

We will be covering more on this ETF once details are officially out and let you know where it will fit in your own portfolio. However, we think in the current Indian debt market, defined maturity ETFs are a better approach in the debt ETF space. This is simply because there isnā€™t an efficient way in which one can build a perpetual debt ETF given the current liquidity and valuation scenario in the Indian debt market.

In fact, a recent circular by SEBI spelling norms for debt ETFS and debt index funds expects a scenario of ETFs in India not being able to mimic the instruments in the index; the circular allows the ETF to deviate up to 20% from the original index. This, in our understanding given the limited information available, seems more like an active strategy than passive.

As more information becomes available, we will be able to weigh the benefits and risks of debt ETFs in a better manner. At this point, it is useful to know that the debt landscape is slowly seeing a change and you may have a larger variety and better strategies in the fixed-income space that you can choose from.

Login to your account
OR

Become a PrimeInvestor!

Get stock & mutual fund recommendations

or
Have an account?
Login To Your Account
OR
Donā€™t have an account ? Register for free