For a long time, Indians believed that debt was the best choice for gentlemen. Bonds rarely defaulted and bond funds were considered to be blue chips in the real sense of the term. Things changed substantially after bonds issued by IL&FS, Essel Group, DHFL and ADAG group defaulted in the last one year. Even investors who were holding bond FMPs felt short-changed after AMCs like HDFC, Birla and Kotak postponed their FMP repayments due to default in repayment by the Essel group. This has largely dented customer trust in bond funds and that is visible in the outflows in credit risk funds. One solution to this problem could be bond ETFs.
What exactly are bond ETFs?
Like any ETF, these bond ETFs will be representative of a portfolio of bonds. Instead of selecting bonds, these Bond ETFs will directly invest in a bond index. This will open the path for creating a plethora of bond indices which can cater to the risk-return preferences of various classes of investors. For example, you can have a G-Sec ETF or an AAA-rated bond ETF or even a corporate bond ETF. Since the ETF will exactly replicate the components of the underlying index, there is no surprise element for the bond ETF investors about the portfolio mix of the fund. That is a major plus over bond funds. In the US, bond ETFs are already a $600 billion market and are growing rapidly. Bond ETFs will offer a passive approach to debt investing.
Bond ETF advantage
The bond ETF as a product will bring a number of advantages to the bond investors. Firstly, it allows the investor to take a passive approach to bond investing. Here investors don’t invest in a portfolio of bond but in an ETF that replicates the bond index. Secondly, bond ETFs are highly cost effective. In case of equities, ETFs give a cost advantage of 50-60 bps over index funds. You can get a similar advantage in bond ETFs also. For bond returns, a 50-60 bps edge can make a substantial difference. Thirdly, bond ETFs are not volatile since the fund does not have to handle fresh purchases and sales. Hence liquidity can be kept at a bare minimum. Lastly, bond ETFs can be structured in a more flexible manner so as to pay dividends with different periodicity to encourage conservative investors to the fold. It is in this light that the Indian government is also exploring the possibility of using bond ETFs against its PSU bonds.
Time to make a start
India has been slow to catch on to the passive investing trend but investors are gradually latching on to the concept. The need of the hour is greater ETF choices with institutional participation and market making support. The time may be ripe for launching bond ETFs and give a boost to passive investing in the bond markets in India! ©