From the point of view of risk, Anil Gupta, V-P and sector head - financial sector ratings, Icra, is of the view that investors need to be mindful of the risk which these ETFs will have because of interest rate movements.
The Cabinet Committee on Economic Affairs (CCEA) on Wednesday approved the creation and launch of Bharat Bond Exchange Traded Fund (ETF), the country’s first corporate bond ETF through which retail investors can invest in corporate bonds with just `1,000.
The ETF will be a basket of bonds issued by Central Public Sector Undertakings (CPSUs) Central Public Sector Enterprises (CPSEs), Central Public Financial Institutions (CPFIs) or any other government organisation bonds.
Initially, there will be only two maturity series of three and 10 years, that is, ETFs maturing in April 2023 and April 2030, respectively. The first of the series to be issued will only have AAA-rated bonds as their constituents.
Some of the top-rated firms like Rural Electrification Corporation (REC), National Bank for Agriculture and Rural Development (Nabard), Power Finance Corporation (PFC), National Highways Authority of India (NHAI) and Indian Railway Finance Corporation (IRFC) will be the top constituents in the ETFs.
With the expansion of investor base through retail and HNI participation which can increase demand for their bonds, the government believes these issuers may be able to borrow at reduced cost, thereby reducing their cost of borrowing over a period of time.
Finance minister Nirmala Sitharaman said investors can buy or sell the ETFs through three different methods. “One is through the exchange itself; the second could be when you are using the route of a market maker. When there are no buyers or sellers, the market maker will buy or sell the units of the exchange traded fund and aid liquidity on the exchange.
To provide for this, what the Cabinet has done is to make the market maker to keep an inventory of ETF units worth `1 crore at a time. The third route can be through the AMC. Large investors can also buy and sell ETF units directly through the alternative method. That process is known as ETF unit creation and redemption. Transaction value for such ones would be `25 crore or above,” Sitharaman said.
The fund, which will likely open for subscription later next week, comes after two years of deliberations between the government and associated stakeholders. Earlier this year, Edelweiss AMC had won the mandate to manage the ETFs.
Radhika Gupta, CEO at Edelweiss AMC, pointed out that one of the prime advantages is that a retail investor can buy a basket of the best corporate bonds in the country at a small amount. “From a retail investor point of view it becomes cost efficient, liquid, transparent, and safe which is the most important thing. We are launching a 3-year and a 10-year ETF now and basis demand, we will continue to launch the ETF series every year. Next year, the current 10-year and 3-year series will become a 9-year and 2-year product, respectively, meaning over time, investors will have a yield curve,” Gupta said.
It will be interesting to note how much demand will the ETFs attract in current times. According to an industry source, collections to the tune of `10,000 crore are expected. Market sources also indicated that returns on the three-year ETF is expected to be in the range of 6.5-6.6% while that on the 10-year ETF could be approximately 7.5%.
The ETF will hold bonds till their maturity and coupons received will be reinvested. The issuer weight is likely to be capped at 15% and weight allocation will be based on outstanding debt amount of the issuer in the particular period.
Rohit Karkera, executive director – investment advisory, Waterfield Advisors, said the bond ETFs would enable deepening the corporate bond market with enhanced retail participation. “The 0.0005% cost structure makes it the cheapest available investment option. Bharat Bond ETF packages in the advantages of an FMP (yield expectations) while negating the downside of an FMP (illiquidity factor). The success, however, will depend upon the market makers’ ability to provide adequate liquidity, which would ensure effective price discovery,” he said.
Market experts believe that the ability of the bond ETFs to mobilise a sizeable corpus would be key to the success of this product, as it would not only drive the liquidity of its units on the exchanges, but also create an alternate channel for mobilisation of resources and growth of debt markets. These ETFs will be traded on an exchange meaning investors can buy or sell units of this fund on exchange at any time during the tenure of the fund. The fund will be managed at a cost as low as 0.0005%.
An element of tax efficiency is also attached with the ETF as bond ETFs are taxed with the benefit of indexation which significantly reduces the tax on capital gains for investor. The ETF will track the underlying index on risk replication basis, i.e. matching credit quality and average maturity of the index. The index will be constructed by National Sock Exchange.
From the point of view of risk, Anil Gupta, V-P and sector head – financial sector ratings, Icra, is of the view that investors need to be mindful of the risk which these ETFs will have because of interest rate movements. “During an increasing interest rate cycle, the market price of the ETF units will decline. Interest rate risk will however be lower in shorter tenure ETFs, and if held till maturity, the interest rate risk will also be mitigated as the ETFs will be redeemed at face value on maturity,” he said.