Published on Dec 17, 2019.

Opening up an important investment avenue for Individual Investors, the Union Cabinet has recently approved the launch of First Bond ETF, called the Bharat Bond ETF. The ETF will only invest in AAA rated Bonds of Public Sector Undertakings. The issue is being run by Edelweiss Mutual Fund and is closing on 20th Dec. There has been a lot about the issue in the news and media and we do feel given attractive features, dwindling trust in credit markets, this issue is appealing for Retail as well HNI Investors.

The issue has two maturities – 1st maturing in April 2023 (3+ Years), the other maturing in April 2030 (10+ Years). While we believe, a three years maturity issue is appealing for the investors who are looking for a better and tax efficient return over Fixed Deposits with a post-tax expected yield of 6.31% (With 4 indexations), the 10+ Years has more than what meet the eyes. This is, the issue may trade  at a good premium or discount due to interest rate sensitivity. We have done a scenario analysis below on the investment of 1 Lacs Rupees in the 10+Years series to understand what may happen in case of favorable interest rate environment over the next one year –

While we think the most likely scenarios are Case I to Case III, our above calculations are based on followings assumptions –

  1. There are rate cuts by RBI as per the different scenarios. As repo is a short-term rate, we have assumed the entire rate cuts are transmitted to the longer end of the curve. I.e. Long-term borrowing rates are down in line with the short-term rates and the same is also reflected in the ETF Yield.
  2. In case IV, V, VI, we have assumed reduction in the term spread. As current spread are at a historical premium (long term spread over short term rates), we have accounted for a possibility of reduction of the term spread along with 75bps rate cut by April 2021 and assumed the same is also reflected in the ETF yield. These are the extreme favorable scenario returns.
  3. Assumed tax slab is 30%. Surcharge is not considered while calculating tax for better understanding.
  4. The bond prices may differ from the above theoretical prices due to inflationary expectations or liquidity of the issue. An investor may also not be able to realize the theoretical gains due to buy/sell spread and allowed spread for the market maker.
  5. There may be adverse impact on yields in case of rate rise. We have not considered those scenarios here.

Disclaimer – The above note is for illustrative purpose only to show probable theoretical ETF prices in the case of  rate cut and does not claim to predict the actual prices/returns. Investors should evaluate the adverse rate scenario, their investment time horizon/objective and consult their investment adviser before making an investment decision.

Clovek Research