pri BOND ETF – A new tool of investment soon to be introduced in India BOND ETF – A new tool of investment soon to be introduced in India

What is Bond ETF?

We all are aware about both the terminology used above i.e. Bond and ETF.  Bond as we know is an instrument of investment which provides us the fix coupon rate of return over the period of certain time.  On the other hand ETF stands for Exchange Traded Fund, the fund which can easily be transacted over the secondary market.

Bond ETF is a type of exchange traded fund, which makes investments strictly and exclusively in the Bonds.  In a way it is like mutual fund the only difference is the product of investment used by both the entities.

History of ETF

The history of ETF lays a way back in 1774 by a Dutch Merchant, who invented an idea of pooling of investment.   That was a concept of close ended investment.  Almost after 150 year the first open ended mutual fund was created, offering its investors an opportunity to buy and sell the shares on daily basis.  In 1990, the first ETF in the world was created in Canada, transforming the whole investment methodology and offering the benefits of pooled investment with trading facility.   Following Canada, United States of America floats its first ever ETF in 1993.  Initially this tool was used by the institutional investors as their trading strategies; however, soon it was captured by the individual investors and financial advisors.

In the year 2002 USA introduced its first ETF.  The Bond ETF was an instrument tracking various bonds of the market and providing a better shell against a sectorial and individual bond risk.  The market was surprised with the success of the ETF Bonds.  In 2002 USA’s Bond ETF market was about $0.1Tn which has reached to $1Tn in 2010 and now reached for more than $3.4Tn.  2014 was the year which was saw a record number of $241Bn of net issuance of Bond ETF globally.

Salient Features of Bond ETF

  • Bond ETF provides a pooled investment facility with easy trading on exchange as well as over the counter.
  • Bond ETF is a long term core investment activity unlike speculation activity of equity market.
  • It provide monthly fix income based on the coupon rate and further they may provide annual dividend.
  • Being ETF these Bonds are traded globally, so there is a worldwide market for this instrument.
  • Diversification of investment provides a better caution in the time of adverse market situation.
  • There is a stipulated regulatory authority, which over watch the activities and methodologies used by the fund houses.
  • There is a sound transparency about where the portfolio is diversified and what the proportion of investment is in a particular segment or sector.
  • Bond ETFs do allow investors to invest with precision in the bond market. They can create their own model portfolios, so it lets investors be in the driver’s seat.
  • Usually an order to purchase or sell the ETF is executed at the price at the end of the day, so there is no need to keep a continuous watch throughout the day.
  • Most of the ETFs are indexed funds they are having lower expense ratio, hence resulting into lower cost of investing.
  • Bond ETF continuously keeps investing in different bonds, so everyday there is a maturity of some bond and entry of new bond. So, eventually there is no maturity date or period for Bond ETF.
  • Bond ETF is also traded in derivative market, providing leverage to an investor against potential loss.
  • Bond ETF provides fixed coupon rate, so in case of hike of interest rate in an open market; there may be some loss of income.
  • No Bond ETF give protection against the capital invested as it is an index traded fund and therefore the price may vary on daily basis.

Global Scenario of Bond ETF

Bond ETFs have survived for many times in stressed circumstances of market from 2008 market fall to European debt crisis, US Treasure downgrade to oil sell-off of 2014    etc.  During all these times it was seen that very fewer bond were trading through over the counter, while on the other hand Bond ETF was facing multifold increase in trading activity.

It is a learned pattern that in every worst situation bond were thinly traded while the ETF has shown shine in trading activity.  Where bonds have failed to perform in critical market situation, the Bond ETF has always outperformed and rose above the condition.

There’s a long way to go. Bond ETF market penetration remains incredibly low relative to equities. The U.S. fixed-income market is roughly twice the size of the equity market today, commanding nearly $50 trillion, but bond ETFs represent only 0.9% of the entire fixed-income market. By comparison, equity ETFs represents 8.5% of the total equity market.

Indian Market Aspirations

Currently Bond ETFs are not allowed to be traded on any of the Indian Stock Exchange.  However, the government is keen to make a start soon and has already initiated the process of ground level work.  Government has floated Request for Proposal (RFP) to appoint advisors for creating the Bond ETF market, which is now beginning to rival equity share ETFs in their depth and maturity overseas. One of the objectives to launch Bond ETF is to cater to the central public sector enterprise or public sector banks and public sector units (PSUs) by leveraging their aggregate strength. About a one year ago India had introduced Bharat 22 ETF to achieve disinvestment targets.  It is an open ended ETF that will invest in similar composition and weightages as they appear in the Bharat 22 Index.  It will be a game changes for many corporates; fund houses and investment bankers to take the financial market of India to altogether another level.

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July 2021