Finance Minister recently announced that India would launch its first-ever "Bond ETF" called 'Bharat Bond.' The bharat bond ETF is a new move to develop an underdeveloped bond market in India. It will ultimately give a boost to debt availability to the PSUs (Public Sector Enterprises).
While ‘Bharat Bond ETF’ opens on December 12, the following piece talks about ETF’s,bharat bond ETF’s and the government’s new reforms in the ETF mutual funds per se.
ETF: The Definition Breakdown
Going by the term 'exchange-traded fund' actually solves most of our problems. First is the fund. Just like any other fund, people pool their resources and form a fund that can provide the advantage of scale. This pool now has a collection of securities.
Second is the ‘exchange-traded.' They are traded on an exchange just like any other stock. Since they are traded on an exchange, they are linked to one of the indexes. Therefore, ETF's are also Index Funds in a way but are different as they are indexed for increasing their liquidity in the market
An index is a marker. For example, to see how companies listed in Bombay Stock Exchange (BSE) are performing, we look for values of Sensex. Therefore, Sensex is the index of BSE.
What would happen if you need money? Either you would sell some of your belongings, or you would borrow from somebody. Whenever a company needs capital for its requirements, it resorts to two options. It may sell its shares. However, it means owners (promoters) will have to give up a pie from their cake. Hence, sometimes companies choose to borrow. Banks may not always entertain, or the rate may be too high.
Therefore, they issue 'bonds' to the public. When you buy the bond, you give the company the money it needs. On the other hand, you would get the interest for the loaned money. Now, just as the shares trade on the stock exchange, bonds trade in a debt market. Although bond trading is a bit different from share trading, we can understand this in a broad fashion.
Say you buy a bond for Rs. 100. You will get 8% interest per annum and the maturity period is ten years. You hold this for three years and get Rs. 24 as interest. What would happen if banks lower interest to 6% on Fixed Deposits? People would wish they had the bond that you have. Someone would come to you an offer you Rs. 105 for the bond. The bond price has risen.
On the other hand, if banks announce FD rates of 10%, you would think of getting rid of the bond and instead invest this money in FD. The demand for your bond has fallen. It might value RS.98 now.
This is how bonds work. The bond market brings buyers and sellers on one platform.
The Bond ETF
The Bond ETF invests exclusively in bonds. They are tradable in the debt market. Unlike debt mutual fund, it is listed on the exchange for direct trading.
A bond ETF is a basket of bonds and that fund is linked to the index.
The Bharat Bond ETF
The Bharat Bond ETF is being launched by the Government of India, which will raise debt for PSUs. Edelweiss Asset Management Fund will manage this fund. The maturity period of the Bharat Bond ETF funds will be three years (2023 Series) and ten years (2030 Series). Yield for three years is 6.7% and for ten years is 7.6%.
Since it will be taxed like a debt mutual fund, post-tax yields would be 6.3% (2023) and 7% (2030). 2023 Series invests in 13 PSUs while 2030 Series in 12 PSUs. The amount of investment will be in multiples of Rs. 1000 with a minimum amount of Rs. 1000.
Since it has a specific duration to be bought and a redemption maturity period, this is a closed-ended fund. However, it can be traded on exchanges. The Bharat Bond will be listed on "Nifty-Bharat Bond Index." It is a new index launched by the government of India and Nifty. This is why the debt bond market would develop in India. Hence, it can be traded like any other share listed in the market. Also, it is launched for those without a demat account. Although, every investor should have a demat account because the benefits of Demat account are huge.
It offers various advantages:
- The expense-paid is lower. Expense Ratio is low when compared to other mutual funds. This is true because fund managers do not have to put effort into daily buy and sell. It is because an ETF rises and falls according to the actual index. It is deliberately designed to follow the index.
- Liquidity is higher because one can sell it on exchange and move out whenever one wants to. They are directly listed on the exchange. Though there is a lock-in of 3 years and ten years, the buyer can sell the stock on exchange and exit.
- Bond ETFs are much safer than stocks because they directly lend to companies and earn fixed interest for it. In the case of liquidation of companies, they are first to be repaid. Though they do not offer as good returns as stocks, they are a viable alternative to fixed deposits with slightly higher yields.
- An advantage that is biggest of all is the tax advantage. Debt funds are taxed on slab rates until three years, but only 20% post that. This means though you might be in the 30% income tax slab, you may save yourself 10% income earned from the bond.
- There may be many other bond ETFs coming up. However, the Government of India backs the PSUs. Although the beneficiary PSUs are quite healthy and profitable, in cases of the failure, the government will have to pay back the money. This makes the bond ETF much safer than other investments.
There is only one shortfall and that is for the investors expecting high returns. The bonds do not have as good returns as stocks. Though the returns are better than fixed deposits currently, they are not in competition to stocks.
However, for those thinking of diversifying a portfolio with a better balance between debt and equity, the time has come.
India's bond market is very underdeveloped, and hence, industries have no option but to depend on banks for loans. This increases interest rates for other consumers. A developed bond market will help enterprises move to the public for investments, and more capital will be available to banks offering cheaper loans.
Irrespective of the success, this step of the Bharat Bond ETF will be historic because it calls for the development of the bond market.