Bond ETF is a type of exchange
traded fund, which makes investments strictly and exclusively in Bonds.
In a way it is like mutual fund with the only difference being the product of
investment.
ETFs are like bond mutual funds
as they hold a portfolio of bonds with different strategies, viz. U.S.
Treasuries bonds and long-term and short-term bonds. Bond ETFs are passively
managed and trade much like stock ETFs on a major exchange. This helps promote
market stability and depth by adding liquidity and transparency during times of
stress.
Although bond ETFs, just like the
other ETFs, make a correlating index or underlying investment product, they are
not as simple as the others. Bonds are usually fixed-income assets and are not
very liquid. Hence, investors hold these bonds until maturity and do not
usually trade them on secondary markets like stocks and indexes. Another
important aspect about these bonds is that their pricing information is not
traditionally transparent. This is where a bond ETF makes a difference. A Bond
ETF work just like any stock ETF. They also track a correlating bond index or
product.
Bond ETFs need to be liquid, and
available to the secondary markets. Also, these cannot afford to have unclear
pricing. These are a few areas that a bond ETF needs to overcome.
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 fixed 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.
Bond
ETFs are transparent about where the portfolio is invested 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
Globally, Bond
ETFs have survived many crises for 2008, European debt crisis, US Treasury
downgrade to oil sell-off of 2014 etc. During all these times it was seen
that very fewer bond were trading over the counter, while on the other hand
Bond ETF was facing multifold increase in trading activity. In terms of crisis,
bond ETFs trading volume increases manifold.
However, There
is 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. 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 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 could be a game changer for many corporates; fund houses and
investment bankers. It may also take the public financial markets in India to a
greater level.
Historically
bond market have been illiquid as compared to stocks and therefore inaccessible
to retail investors. Large issue sizes also prohibit retail investor.
The nature of
trading, which is almost entirely over the counter leading to price opacity,
and large issue sizes of the bonds all combine to make it out of reach for the
average Indian investor.
Bond ETFs can
solve this issue considerably. Bond ETFs have soared in popularity in developed
markets in recent times, because they appear to solve some of the concerns
mentioned above. The widespread perception is that bond ETFs help bring
liquidity to the market.
Bond ETFs allow
both institutional and retail investors to partake in a larger pool of fixed
income securities than they normally could have access to. Multiple bonds are
bought in smaller chunks defined by the ETF price and size, catering to all
appetites. This solves the large issuance size issue.
In the case of
the Indian government bond G-Sec, an ETF provides smooth rollover benefit,
where the latest bond issue replaces the earlier one with no associated cost
for the investor. It can prove to be very cost effective for the average retail
investor to manage.
In addition,
thachieve. Bond ETFs allow for low execution costs and price discovery. Buyers
and sellers can offset each other removing the e corporate bond market ETFs can
be designed to capture desired duration and yield, which makes targeted
exposure far easier to need for frequent buying and selling of underlying
securities.
As bonds ETFs
rise in popularity, buying and selling of such ETFs can far exceed that of the
underlying securities, which contribute to the overall increase in market
liquidity. Price discovery happens as the price of the ETF is a reflection of
the index underlying it, which in turn is determined by the weighted sum of the
underlying securities.
In addition,
the act of trading on stock exchanges, unlike for the underlying securities,
brings transparency to a very opaque market. While investors can buy and sell
ETFs as a single block, they do not have to trade in the underlying securities.
Authorised participants are permitted to trade in the underlying securities of
the ETFs with the ETF sponsor fulfilling the important role of keeping the NAV
(net Asset value) of the ETF in line with the value of the underlying
securities. Even during times of market stress, a bond ETF is at least as liquid
as the underlying securities. Finally, ETFs mandate the underlying securities
to be made public on a daily basis, which makes the investment even more
transparent than a bond fund.
Will
Government Bond ETF be successful?
Bond exchange
traded funds (ETF), similar in structure and intent to a stock ETF, could debut
soon in India, where the government is seeking to enhance liquidity in debt
investments and expand the scope for retail savings.
Government of
India had floated a Request for Proposal (RFP) to appoint advisors for creating
the bond ETF market, which is now beginning to rival stock ETFs in their depth
and maturity overseas. The bid closed May 16.
Bond ETFs would
permit both retail and institutional investors to take exposure in a larger
pool of fixed income securities than they normally could have access to.
Multiple bonds are clubbed in smaller chunks defined by the ETF price and size,
catering to all appetites.
The bond ETF
market is still in a very nascent stage. In fact, some reports suggest that as
on June 2015, this genre of ETFs held about $318 million in assets under
management or less than 1% of the total market. So, even if bond ETFs were to
see a downfall, the event would not impact the bond market at all. Also, unlike
regular bonds where payments happen at fixed intervals, bond ETFs hold
different maturity dates for the different assets. Since these are expected to
be due for a coupon payment at any given time, the bond ETFs pay interest every
month with the value of the coupon changing from month to month.
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Acquisory News Chronicle-May 2018
