Bharat Bond ETFs: Second Tranche opens July 14: Should you invest?

A new fund offer (NFO) of Bharat Bond ETFs will be open for subscription from July 14, 2020 until July 17, 2020. The first series of Bharat Bond ETFs was launched in December 2019. I had written about the first tranche in detail here.

The product structure remains the same. The new series of Bharat Bond ETFs are target maturity bond ETFs i.e. the Bharat Bond ETF will mature, and you will be returned your money on the maturity date.

In this post, let us review the bond ETF concepts and find out about this latest set of Bharat Bond ETF in detail.

What are Bond ETFs and Target Maturity Bond ETFs?

An equity ETF tries to replicate the performance of a benchmark equity index. For instance, a Nifty 50 ETF (from any AMC) will try to replicate the performance of Nifty 50 index.

Similarly, a bond ETFs like the Bharat Bond ETF tries to replicate the performance of a bond index.

This video from Edelweiss explains bond ETFs in a simple manner.

A Target Maturity Bond ETF is a variant of Bond ETFs. A target maturity bond ETF does not have an unlimited life (like open-ended mutual funds) and matures on a particular date just like a bond. A fixed maturity plan (FMP) is a closer cousin.

A video from Edelweiss AMC explaining Target Maturity Bond ETFs

Bharat Bond ETF: Second Tranche: Salient Features

1. 2 Target maturity Bond ETFs
2. Bharat Bond ETF – April 2025 benchmarked to Nifty Bharat Bond Index-April 2025. The ETF matures on April 2025. Matures in ~5 years.
3. Bharat Bond ETF – April 2031 benchmarked to Nifty Bharat Bond Index-April 2025. The ETF matures on April 2031. Matures in ~11 years.
4. The money gets invested in AAA-rated bonds issued by Government-owned entities (public sector units). So, your money is invested in bonds from PSUs like NHAI, HUDCO, Exim Bank, HPCL, IOCL, IRFC, NABARD, National Housing Bank, NHPC, NTPC, Power Grid, PFC, and REC. This ensures limited credit risk.
5. The underlying bonds mature during the 12-month period prior to the maturity date of the bond ETF. Refer to Nifty Bharat Bond Index methodology for more details. This provides predictability of returns.
6. The ETFs do not pay any interest. The interest from the underlying bonds will be reinvested by the fund manager and will reflect in the ETF NAV.
7. The ETFs will be listed on stock exchanges. You can also buy or sell on the stock exchanges.
8. There is no lock-in period. You can sell as soon as the ETFs list on the exchange.
9. Low expense ratio: 0.0005% for the first 10,000 crores. 0.0004% for the next 10,000 crores and 0.0001% thereafter.
10. Can Non-Residents invest? Yes, NRIs can invest in Bharat Bond ETFs.
11. You will need a demat account to invest in Bharat Bond ETF.
12. If you do not have a demat account and do not want to open a new one, you can still invest. You can invest in the Fund-of-Funds (FoF). This FoF will invest in the Bharat Bond ETF.
13. Minimum investment in the NFO: Rs 1,000
14. Edelweiss AMC is managing the issue.

What are the expected returns?

The indicative yield for the Bharat Bond ETF- April 2025 is 5.49% p.a.

The indicative yield for the Bharat Bond ETF- April 2031 is 6.65% p.a.

This data is as on July 8, 2020.

Since the money will be invested in bonds that mature during the 12 months period prior to ETF maturity date, your returns (if you buy in NFO and hold until maturity) will be in this range only.

If you buy or sell in the secondary market once the ETFs are listed, your return experience can be quite different depending on your purchase and sale price.

Even for the buy-and-hold investor, the returns can be a bit different. The yields mentioned above are for the benchmark index and as on July 8, 2020. By the time your money gets invested, the benchmark yield could change. Moreover, there will be some tracking error.

Additionally, there is some re-investment risk arising from re-investment of interest from underlying bonds and due to instances of bond maturity before the ETF maturity.

How is Bharat Bond ETF different from debt mutual funds?

A Debt mutual fund scheme can be alive forever. A Target Maturity Bond ETF such as Bharat Bond ETF will close (and the money returned to investors) on the ETF maturity date.

Most debt mutual funds are actively managed. Bharat Bond ETF is passively managed and thus carries no fund manager risk.

Debt mutual funds, depending on the category, can invest in bonds with different credit profiles. Bharat Bond ETFs track Nifty Bharat Bond Index and invest only in bonds from Government-backed entities. Thus, default risk is limited in Bharat Bond ETFs.

Bharat Bond ETF offers greater returns predictability than debt mutual funds.

In a debt mutual fund, the fund manager will strive to maintain the duration profile of the portfolio as per the fund mandate. For instance, for medium-to-long duration fund, the fund manager will maintain the portfolio duration between 4 to 7 years. Even after 5 years, the duration will be the same as the fund manager keeps replacing the bonds to maintain the duration (maturity) profile.

In the target maturity bond ETFs, the maturity (duration of the portfolio) and hence the interest rate risk will reduce with time.

How will the income from Bharat Bond ETF be taxed?

The ETF does not pay any interest. Since there is no interest income, there is no question of this income being taxed.

There will be capital gains (or capital loss) if you sell the investment in the secondary markets or when the ETF gets redeemed at the time of maturity.

The tax-treatment is the same as for debt mutual funds.

If the holding period is less than or equal to 3 years, the resulting capital gains will be treated as short term capital gains and taxed at your slab rate.

If the holding period is greater than 3 years, the resulting capital gains will be treated as long term capital gains and will be taxed at 20% after indexation.

Note that you can hold debt mutual fund units forever. However, you cannot hold the units beyond the maturity date.

Hence, if you buy the bond ETF from the secondary market, hold the units until maturity but the maturity date is less than 3 years away from the purchase date, any capital gains arising from the redemption of ETF units will be considered short term capital gains and taxed accordingly.

The maturity dates of 5-year ETF and 11-year ETF are in April 2023 and April 2030 respectively. For a hold-till-maturity investor, this will provide an additional year of indexation benefit.

What are the pros of investing in Bharat Bond ETF?

1. Low expense ratio: The ETF has an expense ratio of 0.0005% (for the first 10,000 crores of AUM). This is quite low compared to the expense ratio of debt mutual funds.
2. Safety (Low Credit Risk): Since these are Government-backed entities, there is very low probability of default on any of these bonds. If you constantly worry about your debt mutual fund portfolio, Bharat Bond ETF could be a good alternative.
3. Transparency: Since the ETF will track an index, you do not have to worry about the fund manager risk. Recently, the investment decisions of many AMCs in the debt fund space have been called into question. The portfolio will be available daily.
4. Predictability of returns: Target date maturity structure and the index rules give you a fair idea about hold-till-maturity returns.

Things you must understand before you invest

We are looking at only the indicative yields. And these yields can change by the time your money gets invested. This happened in the first tranche of the Bharat Bond ETF.

For instance, the indicative yields for the Nifty Bharat Bond Index- April 2025 and Nifty Bharat Bond Index- April 2031 were 6.04% p.a. and 7.04% p.a. on May 31, 2020. (Source: Bharat Bond ETF: Leaflet).

As on date (July 8, 2020), the yields are 5.49% p.a. and 6.65% for April 2025 and April 2031 indices respectively (Source: Bharat Bond website). The latest yield is also available on NiftyIndices website. By the time your money eventually gets invested, the yields may be lower (or higher).

And these are indicative yields for the index. There will be some tracking error for ETF and the FoF. Given the Nifty Bharat Bond index methodology, there can be good churn in the index (or so I believe). Given the liquidity in the bond markets, this can also increase tracking error in the ETF (and FoF).

Moreover, the Nifty Bharat Bond index selects bonds that are maturing during 12 months prior to the maturity date of the index. Therefore, there is an element of reinvestment risk too.

You are fine if you are holding until maturity. If you are investing in the NFO and plan to hold until maturity, you should get close to indicative yields.

However, if you plan to sell in the secondary market or are forced to sell in the secondary market, you are exposed to the interest rate risk (it can work both ways though). Moreover, liquidity can be a problem. You may have to sell at a discount to the NAV.

We know an ETF has two indicators of value. NAV is the value of the underlying assets in the portfolio. Price is the trading price on the exchange. On the secondary market, you can buy or sell only at the best bid or ask price (trading price). And there can be a divergence between the price and the NAV. I copy the data for Bharat Bond ETF-April 2030 since inception from ValueResearch.

For more on how ETFs work and the difference between the price and the NAV, refer to this post.

If you plan to exit in the secondary market, you are exposed to both interest rate and liquidity risk. The interest rates risk goes down as you move closer to maturity.

If you want to hold until maturity, you can be indifferent to the interest rate and liquidity risk. There will be some re-investment risk though.

Bharat Bond ETF Performance until now

I compare the performance of Bharat Bond ETF 2030 with its benchmark (Nifty Bharat Bond Index 2030).

There was some delay in deploying the funds in the first tranche. And this has led to a difference in performance, apart from the usual tracking issues. I would expect these inefficiencies to reduce in the coming tranches.

Should you invest in Bharat Bond ETF?

If you want to hold this bond until maturity, this can be a good investment for your long-term fixed-income portfolio. There is limited credit risk. This, being a target maturity bond ETF, gives you a good indication of the long term returns upfront. To some extent (not completely), you lock in the returns until maturity. A peaceful investment. You must not worry much. You get indexation benefit if you hold for the long term. This makes it quite useful for investors in the 20% or 30% income tax bracket.

You can use Bharat bond ETFs in many ways. For instance, you can use Bharat Bond ETFs to build a ladder of fixed-income investments. Now, you have Bharat Bond ETFs maturity in 2023, 2025, 2030, and 2031. Expect more such issuances in the future. You can simply invest in respective Bharat Bond ETFs in accordance with income requirements for various years and forget about it.

You do not get interest income from Bharat Bond ETF or FoF. The interest income in the underlying bonds gets added in the NAV. To generate regular income, you will have to sell ETFs in the secondary market. This is always tricky since there may not be enough liquidity. There is an option of Fund-of-Funds (FoF) though. You can set up SWP from the FoF if you wish. Note that FoF will have an additional cost.

You must, irrespective of your income tax bracket, consider other options before investing in Bharat Bond ETFs. For instance, if you are considering a long-term fixed-income portfolio investment, PPF and EPF are good alternatives. While the interest rate keeps changing in EPF, VPF, and PPF, we know that these instruments offer advantageous rates.  At the same time, there are limitations on investment amounts in PPF and EPF too. I prefer PPF and EPF.

If you are looking for regular income, you can compare returns from bank fixed deposits, post-office fixed deposits, and RBI floating rate savings bonds.  If you are a senior citizen, you can consider PMVVY and SCSS too. The banks also offer higher rates to senior citizens. However, the interest income from these products is taxed at your marginal tax rate which can reduce post-tax returns for higher income tax bracket investors substantially.

As always, you can see the answer is not simple. It is nuanced. Your choice will depend on your investment horizon, income tax bracket, liquidity preference, and your specific requirements.

Do you plan to invest in Bharat Bond ETFs?

Additional Links

Nifty Bharat Bond Index – April 2025

Nifty Bharat Bond Index – April 2031

Nifty Bharat Bond Index – April 2031 Factsheet

Nifty Bharat bond Index – April 2025 Factsheet

Bharat Bond FAQs

Nifty Bharat Bond Indices Methodology Document