Radhika Gupta
After marking its footprint in developed markets, passive investing is gaining popularity in India over the last couple of years. Equity Exchange Traded Funds (ETFs) have gained the most from this popularity, with more than Rs 1.38 lakh crore of assets being managed in these ETFs. Gold ETFs manage around Rs 5,800 crore, but there are virtually none on debt side. With only two G-Sec ETFs with a mere Rs 4 crore AUM (assets under management) and no ETFs in the bonds space, there is a big vacuum that needs to be filled up soon.
Globally, Bond ETFs have crossed $1 trillion in AUM, this is around 25 per cent of the entire $4 trillion AUM under various types of ETFs. In India, bond ETFs have a long way to go. To fill this void, the Government of India has planned to launch India’s first bond ETF that will invest in the bonds of Government owned entities.
Slow to take off in India
Investors today are aware of debt mutual funds, but ETFs and specifically bond ETFs are yet to gain traction in India. Bond ETFs, as the name suggest, are passive funds that are traded on the exchange and invest in bonds just as conventional bond mutual funds do. Unlike traditional open-ended bond funds, these schemes trade on the exchange throughout the day. They charge much lower costs compared to actively managed debt funds. Like equity ETFs, these Bond ETFs closely track the index, allowing investors to buy or sell while investing in fixed income securities. Most bond ETFs seek to track indexes that follow specific segments of the bond market, such as government, corporate and PSU bonds. Bond ETFs also seek to track specific maturity buckets, such as short, long, and medium terms. There are also bond ETFs with defined maturity for, say, three years, five years and 10 years and are called target maturity bond ETFs. They are similar to Fixed Maturity Plans (FMPs) which investors are already familiar with as they carry the additional benefits of liquidity and low cost.
Form an investor’s point of view, bonds, open-ended debt funds and bond ETFs might look similar as investment avenues, but all these options have different features. Bond ETFs have three distinct advantages – Liquidity, transparency and low cost.
Liquidity
Structural issues in the Indian bond market have made trading in bonds difficult for retail investors. While regulators are working to address these issues, it will take some time before retail investors can easily trade in bonds. Bond ETFs can help tide over these issues and facilitate low-cost bond exposure, without structural challenges such as price transparency and liquidity.
Bond ETFs provide liquidity in two ways, through the exchanges and directly through the AMC. On the exchanges, the AMC ensures that the ETF trades at a price closer to its fair value by appointing market makers who facilitate trades. Market makers buy and sell units on the exchange in order to provide liquidity and keep the ETF price closer to their fair value. While most retail investors can transact in ETFs only on the exchange, they can also trade directly through the AMC in multiples of the basket size. In such cases, the AMC creates or redeems ETF units at the prevailing market value, i.e., at the live NAV.
Transparency
Bond ETFs provide easy access to a diversified bond portfolio in a fairly transparent way. Being an ETF, its holdings are disclosed daily, unlike in the case of bond mutual funds where the portfolio is disclosed only once a month. Bond ETFs also provide live price which is quoted on exchange following every trade allowing investors to know the fair value of the portfolio during the day. The bond market is relatively opaque. Trading, particularly of corporate bonds, happens via a fragmented dealer network. Trade reporting occurs with a delay and many bond-issues barely trade, if at all. This makes bond-pricing difficult. Since Bond ETFs are traded on the exchanges, they overcome these drawbacks and help investors with adequate information for taking informed investment decisions.
Low Cost
Since Bond ETFs follow a passive investment strategy by mirroring an index, they come at lower costs compared to traditional actively managed bond mutual funds. Globally, Bond ETFs have expense ratios in the range of 10 to 20 bps compared to 30 to 50 bps in actively managed bond mutual funds.
To conclude, bond ETFs combine the best of both bonds and debt funds. Target Maturity Bond ETFs provide predictable returns like FMPs, if they are held till maturity.
(The writer is the Chief Executive Officer of Edelweiss Asset Management Limited (EAML) and the views expressed above are her own)
Edelweiss Mutual has been appointed by the Government of India to launch India’s first bond ETF.
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