After a long time, the Indian mutual fund investor has - will soon have - a genuinely new kind of investment option. The Bharat Bond ETF is a debt fund. Nominally, it's a corporate debt fund and while there are many corporate debt funds in India, this ETF is unlike any of the previous ones. This is a fund that will have investments only in bonds issued by a select set of central government PSUs. This is an interesting and important kind of fund, especially in the situation that India's debt mutual fund investors are in now. This fund could turn out to be a very good deal indeed for Indian savers who need a reliable and tax-efficient fixed income investment option.
By name and ancestry, the Bharat Bond ETF is a sort of companion fund to the Bharat-22 Equity ETF that the government had launched in 2014 and the CPSE ETF that was launched later. At that time, I had said that apart from some launch discounts, etc. that were offered, such funds were not, in principle, a good idea for investors. My reasons were straightforward. One, it's never a good idea for fund investors to buy a theme-specific fund. And even if one accepts that a thematic fund might make sense at a point of time, that theme has to be about investing. It could be finance, or pharma, or auto or something like that, which you think will do better than the rest of the market.
However, I reasoned that the Bharat-22 ETF or the CPSE ETF were not like that. Instead, these were a rather strange entity - thematic funds where the theme was that the Government of India was the promoter and manager of the companies. From an investor's point of view, this was not much of a logic for investing. At best an investor could consider it to be a diversified fund, but then why would that investor not invest that money into an actual diversified fund? The government had thrown in a special pricing sweetener so there was some incentive, but that was that.
However, PSU equity and PSU bonds are two entirely different kettles of fish. None of the inherent disadvantages of investing in the equity of government-managed companies exist when it comes to investing in the bonds of these companies. While being government-owned is not a useful theme when it comes to equity, it's an extremely useful theme when it comes to bonds!
For all practical purposes, one can consider the underlying bonds to be government-backed. I would say that the default risk of the set of companies whose bonds will constitute the fund is zero. Given the turmoil that debt fund investors have faced, this is a crucial point. Over the last few months, there has been a series of debt-quality problems in a variety of debt funds. Statistically, the issue is small. Of the total amount of debt investments by mutual funds, only a tiny amount is under threat of becoming NPA. However, the damage to debt fund investors' psyche seems to have been considerable. The idea that one needs to be worried about capital losses in debt funds used to be quite unfamiliar to debt fund investors. The Bharat Bond ETF offers an entirely new and effective way out of this problem. The combination of the returns of a corporate bond fund with the freedom from worrying about defaults is a valuable quality nowadays.
Debt funds are also quite tax-efficient when held for more than three years with a tax rate of 20 percent with inflation indexing. Taxation on other forms of guaranteed fixed-income options is always at the investors' tax slab, obviously without indexation. The advantage will be considerable.
All things considered, for investors who want a conservative fixed income investment with tax efficiency and safety, the Bharat Bond Fund is likely to deliver the goods.