Bharat Bond ETFs 2025 & 2031: Why you should not buy such products!

Published: July 6, 2020 at 9:01 am

The second tranche of Bharat Bond ETFs from Edelweiss AMC will be available for purchase from July 14th 2020. Here is why investors should not buy such products in the name of safety.

What is Bharat Bond ETF? It is a passively managed, fixed maturity, open-ended bond exchange-traded fund (ETF) tracking Nifty BHARAT Bond Indices that comprise of AAA-rated bonds issued by government-owned entities. Bharat Bond ETFs are designed liked Fixed Maturity Plans (FMPs) than can be freely traded.

What is a fixed maturity bond ETF? The ETF will have a fixed maturity date, and the bonds in the portfolio will always have a duration less than the maturity date.  In an open-ended ETF, the fund will keep buying new bonds upon maturity of the existing bonds (or earlier). A fixed maturity ETF will try and hold the bonds up to maturity.  For example, a three year Bharat Bond ETF will hold bonds that mature within 12 months of the maturity date. The residual maturity of the 3-Y ETF is 282 years.

What are the advantages of a fixed-maturity ETF? This combines the ability to sell at the exchange at any time (at least theoretically) and eliminates interest rate risk and credit rating change risk if the bonds are held up to maturity and do not default. Since the portfolio will only consist of bonds in which the government has a stake, the risk of default is the second-lowest after sovereign bonds.

What are the new Bharat Bond ETF NFOS? Bharat Bond ETF 2025 (5Y maturity) and Bharat Bond ETF 2031 (11 years). The Nifty BHARAT Bond Index – April 2025 has an indicative yield of 5.65% and the Nifty BHARAT Bond Index – April 2031 has an indicative yield of 6.76%. These are not the returns you would get if you buy and hold. These are the yields of the current index portfolio. With time when the portfolio changes, the yield will change. The NFO period is from 14-17th July. The ETFs will be available for purchase in the secondary market after listing.

What are the existing Bharat Bond ETFs? BHARAT Bond ETF – April 2023 (3Y) and BHARAT Bond ETF – April 2030 (10Y) both launched in Dec 2019.

How are Bharat Bond ETFs taxed? Like debt mutual funds. Gains from units sold on or before the completion of three years would be taxed as per slab. Gains from older units would be taxed at 20% (+cess) after indexation (inflation purchase price with inflation). See examples here: How indexation benefit lowers tax on debt, gold & international mutual funds.

Do we need a demat account to invest in Bharat Bond ETF? Yes. It is not possible to buy ETFs otherwise. The only other option is to pay a little extra and buy a fund of fund investing in these ETFs.

Will Bharat Bond ETF only hold AAA-rated bonds? It will start out with an AAA-rated portfolio. If a bond falls below AAA but is above BBB- (investment grade), the bond will be removed from the index only in the next calendar quarter. Only if becomes junk will the bond be removed from the index in five days.

Is the return of principal guaranteed? No. While the underlying risks are comfortably and acceptably low, no such guarantees can be made.

Are returns guaranteed? No, they are not.

Are returns predictable? Will I get the indicated yield if I hold until maturity? A little too much is being made out of “predictable returns”. This means nothing. Even if one holds the ETF until maturity, the final returns will be governed by market forces.

For example, the interest received by the fund will be reinvested into the portfolio. The yield of the bonds could be lower at that time (bonds priced higher) resulting in a deviation from the estimated yield on creation. This is known as reinvestment risk.  Over three years, this is likely to be minimal but can be significant over ten years.

Any changes in the bond portfolio (note that there is no rigid mandate to hold the bonds until maturity), especially a rating downgrade resulting in the need to sell the bonds, will impact yields.

What the min and max investment limits for retail investors? These limits apply only during the NFO period. Min: Rs. 1000. Max: Rs. Two lakh.

What are the risks associated with Bharat Bond ETF?  For those who wish to buy and sell freely: (1) Credit risk is the lowest among non-govt bonds (but not zero). (2) Interest rate risk (or bond yield fluctuation risk) is quite high. In early March 2020, the 3Y ETF fell by 3% while the 10Y ETF by about 5%. They recovered because of RBI liquidity infusion, but such falls are to be expected. (3) Price-NAV disparity (liquidity risk) is also quite high. The 10Y ETF has a 2% deviation (price above NAV) for about a week in April 2020. The 3Y ETF price was about 1% below NAV for almost three weeks in April-May 2020. The trading is not yet frequent, and if scared investors buy and hold, it could never be frequent.

For those who wish to buy and hold for 11 years:  Locking away money for that long a period in the name of safety would either ensure post-tax returns below inflation or make portfolio management, in particular, rebalancing difficult. An open-ended gilt fund instead of this ETF is a superior choice over 11 years. It allows full liquidity, periodic purchase at a fair price and the chance of a superior return. See: Can we invest via SIP in gilt mutual funds for the long term?

For those who wish to buy and hold for five years: At current yields, the post-tax return would be about 4.6%. For those in the 20% slab, this is only marginally better than a 4.3% (post-tax) 5Y SBI FD.  A post office 5Y time deposit offers 6.7% pre-tax and a post office 5Y RD 5.8% pre-tax. Those in lower slabs, an FD is simpler and better. Even for senior citizens, this is not particularly attractive as fixed deposits carry an Rs. 50,000 income tax exemption.

For those in 20%, 30% or higher slabs, a carefully selected Arbitrage fund (that does not invest in risky bonds) is a better option. The gains have a one lakh tax-free limit and 10% + cess on the rest.

This product is best suited for institutional investors like insurers, fund houses, pension products etc. Retail investors can give this a miss as there are better options available.

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