Bharat Bond ETF 2032: Review: Who should invest?

Edelweiss has launched Bharat Bond 2032 ETF and Fund-of-Fund (FoF).

In this post, let’s see how the Bharat Bond ETF/FoF works. How are these different from regular debt mutual funds? What are the merits? Who should invest? Who should not?

What is Bharat Bond 2032 ETF and FoF?

1. Target maturity ETF/FoF. This means the product will mature on specific date and money returned to investors.
2. Tracks the performance of Nifty Bharat Bond Index-April 2032
3. Nifty Bharat Bond Index-April 2032 comprises of AAA rated PSU bonds maturing on or within 12 months before the maturity date of the index.
4. Available as Fund-of-Fund too. The FoF will invest in the Bharat Bond 2032 ETF.
5. Lower expense ratio of the ETF: 0.0005% (Note that tracking error can be higher).
6. FoF will have dual incidence of costs (expense ratio of both the ETF and the FoF).
7. You will need a demat account to invest in the ETF. You do NOT need a demat account to invest in the FoF.
8. After the NFO, the ETF can be bought or sold on the stock exchanges. Or you can buy or sell the FoF units from the AMC.
9. No interest payout from the product. If you need income, you will have to sell the ETF/FoF.
10. Tax efficient returns due to indexation benefit (if you hold the investment for over 3 years). Sale before 3 years: Capital gains taxed at your marginal rate. Sale after 3 years: Capital gains taxed at 20% after indexation.
11. No interest payout. Interest from the underlying bonds gets reinvested. This also results in reinvestment risk.
12. Non-resident Indians (NRIs) can also invest.

If you are not comfortable with the concept of Bond ETFs and Target Maturity ETFs, here are a few explainer videos.

Links to my posts on the previous tranches of Bharat Bond ETF: Link 1 Link 2

I like Bharat Bond ETFs. Why?

Because it takes away some of my common concerns about debt mutual funds.

There are two major risks that any debt mutual fund investors face.

1. Credit Risk (or default risk): The risk that the bond in which the debt fund has invested defaults on payments).
2. Interest Rate risk (duration risk): Interest rates and Bond prices are inversely related. If the interest rates go up, the bond prices (and debt fund NAV) will go down and vice-versa. However, not all debt mutual funds will go up (or down) by the same percentage when the interest rates go down (or go up). Duration (commonly referred to as maturity) is a measure of interest rate sensitivity of bonds/debt mutual funds. In simple words, longer maturity bonds will have higher duration and be more sensitive to interest rate movements.

For more on risks in mutual funds, refer to this post.

Firstly, since Bharat Bond ETF invests in AAA rated PSU bonds, my concerns about credit risk are obviated.

Secondly, the interest rate risk goes down as the time progresses. For instance, Bharat Bond 2032 has a little over 10 years to maturity (as on December 1, 2021). After 4 years, the bond will have only about 6 years to maturity. As the time to maturity goes down, the duration risk also goes down.

Finally, there is predictability of returns. When you invest Bharat Bond ETF/FoF, you can look at the YTM (yield-to-maturity) of the fund (available on ValueResearch and Bharat Bonds website) and get a sense of your tentative returns if you were to hold the product until maturity. Of course, there will be some tracking error and deviation due to reinvestment of interest at different yields) but you get a good idea about prospective returns.

How are Bharat Bond 2032 ETF/FoF different from other debt mutual funds?

Debt mutual funds can invest in different kinds of bonds, depending on the fund mandate. Gilt funds invest in government bonds. Liquid funds can invest in treasury bills or corporate bonds maturing in up to 90 days. Money market funds can invest in only money market instruments and so on. Now, with most funds, there is no restriction that the fund manager cannot invest in riskier bonds. Even though you would expect fund managers to NOT take unnecessary risk, they can still make mistakes. In other words, there can be default in underlying bonds.

In Bharat Bond ETF/FoF, your money is invested in AAA rated PSU bonds. While you can question the AAA rating, the PSU tag gives a lot of comfort. Therefore, even though PSU bonds can’t be considered as safe as Government bonds, I think it is unlikely that these PSU bonds will default. Takes away my concerns about credit risk.

Now to the interest rate risk.

Regular mutual funds have infinite lives. You can expect many of the existing funds to be around (in some form) even after 100 years.

Target maturity ETFs/index funds have finite lives. For instance, Bharat Bond 2025 will mature in April 2025. On the maturity date, the investment value will be returned to the investors. And the fund will close.

How does this help?

Let’s consider a constant maturity gilt fund that has maturity of 10 years (duration will be less than 10 year). As on date (December 1, 2021), Bharat Bond 2032 also has maturity of over 10 years. Hence, both have similar maturity profile. And carry similar interest rate risk.

However, after 5 years, the constant maturity gilt fund will still have maturity of 10 years (because that’s the mandate). On the other hand, Bharat Bond 2032 will have only 5 years left for maturity. Hence, the interest rate risk will be considerably lower than the constant maturity gilt fund.

In other words, if you have decided to hold the Bharat Bond until maturity, you can be indifferent (mostly) to the interim interest rate movements.

You can also be indifferent to the interest rate movements if you decide to hold the bond/ETF for period equal to current duration. But this aspect is slightly esoteric.

Who should invest?

Let’s first relook at the pros:

1. Limited credit risk (I wouldn’t expect defaults on the PSU bonds)
2. Low expense ratio
3. Zero fund manager risk: The ETF tracks the Nifty Bharat Bond 2032 index.
4. Interest rate risk goes down with time
5. Predictability of returns: You can look at the YTM and get a good sense of your returns if you hold the product until maturity.

Clearly, if these features appeal to you, you can invest.

You can also look at Bharat Bond 2032 if it matches with your cashflow requirement. For instance, if you are retiring in 2032 or 2033 and want to invest in a fixed income product around that time, you can look at Bharat Bond 2032.

Or you could go back to the portfolio basics about building a long-term portfolio and see if Bharat Bond 2032 could be part of satellite portion of your long term fixed income portfolio.

Note that Bharat Bond 2032 is not the only target maturity ETF around. There are many target maturity products in the fixed income space from various AMCs. It is not even the only Bharat Bond ETF around. You can Bharat Bond ETFs/FoFs maturing in 2023, 2025, 2030 and 2031. I have compiled the list of various target maturity products below.

These products will have different risk profiles, YTMs and cashflow timings. Choose accordingly.

You must also look at your cashflow requirement and compare against competing fixed income products. There are bank fixed deposits, Government bonds, corporate bonds, RBI floating rate bonds, PPF, EPF, SCSS, PMVVY etc. Each product has different return, credit risk, duration risk, liquidity, cashflow and tax profile.

Who should not invest?

Bharat Bond 2032 is a long duration product. Matures in 2032.

Thus, Bharat Bond 2032 will be very sensitive to interest rate movements. Can be quite volatile. If you think interest rates will go up soon and are worried about short term volatility, you should avoid this product.

Additionally, I would suggest that you don’t invest in Bharat Bond 2032 for my short-term goals (a few months to a couple of years away) unless you believe that the interest rates will move down (or at least not go up). Don’t just go by higher YTM in Bharat Bond 2032 compared to short duration products.