Bharat Bond ETF: What to do if you missed the NFO bus

Come January and the rush to make investments to save taxes will gather pace. This may lead to people taking investment decisions in a hurry that may not align with their long or short term life goals. Experts say goal-based tax efficient investments rather than last minute tax saving-based investment options are how one should do their tax planning.

Finding a tax efficient investment and safe option that also gives you predictable returns is indeed tough. However, there is one latest offering that may not be tax exempt but is much more tax efficient (especially if you are in 30 per cent tax bracket) and at the same time more liquid than fixed deposits and other investment avenues - Bharat Bond exchange-traded fund (ETF), India's first corporate bond ETF with a fixed maturity of three years and 10 years. While the new fund offer (NFO) of the same closed last week, it is expected to list on the bourses by December 31.

Bharat Bond ETF combines the features of close-ended fund and exchange traded fund, that virtually makes it an open-ended target maturity product. Since it is a debt fund, if you liquidate your investment before the completion of three years, you will have to pay short-term capital gains tax as per your applicable tax slab. In case you liquidate your money after three years, the long-term capital gains (LTCG) tax at 20 per cent post Indexation benefit will be applicable, excluding surcharge.

"From the perspective of tax planning, Bharat Bond ETF offers a return of 6.83 per cent for a tenure of three years and 7.75 per cent for a tenure of 10 years. The interest from the bonds is taxable at the slab rates of the taxpayer. The effective rate of return is higher compared to other fixed-income instruments such as fixed deposits for the highest tax slab of 30 per cent," says Archit Gupta, founder and CEO, Cleartax.

How to invest

The NFO of the Bharat Bond ETF, which will invest in high Quality AAA-rated public sector bonds, received great response from investors with 1.7 times subscription, collecting Rs 12,000 crore. Once it gets listed on the bourses, it will be open for buying and selling.

Also read: Bharat Bond ETF receives great response; over-subscribed 1.7 times, collects Rs 12,000 crore

"To ensure liquidity in the secondary market, market-makers will be appointed who will provide quotes in the absence of any other market participants. The AMC will try to ensure that enough liquidity is available over the exchange since they have plans to come up with new series in the coming years. However, liquidity can only be known once the ETF actually starts trading," says Deepak Jasani, head - retail research, HDFC Securities.

Besides, if you don't have a demat account, you can still invest in it via Bharat Bond Fund of Funds (FoF), which is an open-ended mutual fund that invests in Bharat bond ETFs of respective maturities. You can even start a systemic investment plan (SIP) in the FoF.

"One can start a SIP once the scheme re-opens for regular investments. The scheme will re-open within five days of the allotment date," says Radhika Gupta, CEO, Edelweiss AMC.  

There will be an exit load of 0.10 per cent if you redeem or switch out on or before the completion of 30 days from the date of allotment of units.

Bharat Bond ETF versus Bharat Bond FoF

Both ETF and FoF are liquid but due to their different structures, their settlement periods differ. "ETFs can be liquidated based on live market price and settled on T+2 basis, while FoF can be liquidated based on the transaction day NAV and is settled on T+3 basis. As the underlying assets of both ETF and FoF are same, they both enjoy indexation benefit and LTCG is taxed at 20 per cent post indexation," says Gupta.

The expense ratio of FoF will be slightly higher than the ETF as former will have to bear expenses of underlying but the impact of the same will be negligible. "The ETF will run at almost zero cost (0.0005 per cent). The Total Expense ratio of Bharat Bond FoF will be 0.0515 per cent including the cost of underlying ETF," says Gupta.

Risks in Bharat Bond ETFs:

Just because this is a product with indirect support of government does not mean that it comes without any risk. Price risk (in case of ETF), duration risk, credit risk, reinvestment risk and liquidity risk are some of risks associated with all debt funds and Bharat Bond ETF will not be an exception.

Price Risk: The ETF has a target maturity. This means the initial yield is locked if the investment is continued until maturity. However, if you withdraw/redeem before maturity, price risk will remain.

Duration Risk: "The 10-year variant will have a higher duration risk compared to the three-year option. Yields of 10-year option might come under pressure after the recent RBI's announcement of 'operation twist', where buying of long-end bonds and selling of short-end bonds will be conducted to reduce the term spread. 10-year G-sec on Dec 20th saw its yields crashing and ended 15bps lower at 6.59 per cent."

Credit risk: Since each bond issuer is either a CPSE (Central Public Sector Enterprise), a PFI (Public Finance Institution) or a PSU (Public Sector Undertaking) with a credit rating of AAA, credit risk is relatively lower.

Reinvestment Risk: Gupta of Edelweiss AMC says coupons/interest received by the fund will be reinvested in the similar underlying assets as that of the index or the portfolio, mitigating the reinvestment risk.   

Liquidity risk: What if you don't find many buyers when you have to sell your ETF? You will have to sell it at a discount. This risk specially assumes significance when the product is new and not tested. However, in case of Bharat Bond ETF it will be taken care of by market makers who will buy the units of ETFs directly from the AMCs in large volumes and keep inventory of units so that investors can buy/sell their units anytime during the trading hours. How effective the mechanism will be, will be known only after the ETF starts trading.

Thus, if you are a conservative investor, Bharat Bond ETFs and FoFs are a good way to earn predictable returns at low fund cost and taxes.

Also read: Bharat Bond ETF NFO closes today: 10 things to know about India's first corporate bond ETF