BOND ETFs (Exchange Traded Funds)

It is well known that investors in India, save in Fixed income instruments like Mutual Funds.  One product which is gaining popularity day by day and is till now missing in India is Bond ETFs.

1. At global level bond ETFs have gained good populartity and has good growth.
2. They account for one trillion dollar AUM across various ETFs.
3. In India we find that retail participation in Corporate bond market is observed to be shallow due to structural challenges like poor accessibility, lack of transparency and general awareness.
4. It is believed that bond ETFs can tide over these problems and thus play an important role in increasing the real investor participation in Corporate Bond market.

What are ETFs?

• These are passive funds traded on exchange and invest in bonds just like conventional bond mutual funds.
• Throughout the day these funds trade on the exchange with a much lower cost compared to actively managed debt funds.
• Also AMC ensures that ETFs trades at a price closer to its fair value by appointing market makers.
• Like Equity ETFs bond ETFs closely track the index thus allowing the investors to buy or sell while investing in fixed income securities.
• Bond ETFs have two different structures
  • One which tracks specific maturity segments like short, medium and long term and
  • Second with specific target maturity which are latest innovations and are more suitable or Indian markets.
• Short and medium term bond ETFs are like open ended mutual funds, target maturity bond ETFs are like fixed maturity plans (FMPs) and they mature like bonds since they have a specific maturity date.
• Like individual bonds, here investors are exposed to lesser interest rate risk over time as bond ETF approaches the maturity date.

Distinct advantages of Bond ETFs:

1. Unlike structural issues which makes trading bonds difficult for investors bond ETFs provide liquidity through exchange and directly through AMC.
2. Being an ETF it has transparency of holdings that are disclosed daily unlike Bond mutual funds where portfolio is disclosed once in a month.
3. Bond ETFs follow a passive investing strategy by replicating index and has low costs compared to traditional actively managed bond mutual funds and have expense ratio in the range of 10 to 20 BPS compared to 30 to 50 BPS in actively managed mutual funds.