All About BHARAT Bond ETF

– By Meghashyam Sinkar

We have already seen two successful equity ETFs , namely Bharat 22 and Central Public Sector Enterprises (CPSE) from the Government . Recently the Union Cabinet has approved the launch of India’s first corporate bond ETF – Bharat Bond.

What is ETF ?

ETFs are a basket of securities , similar to mutual funds (MF’s), but are traded on the secondary market like stocks and bonds.

The Bharat Bond ETFs will comprise bonds issued by public sector units, enterprises, financial institutions and other government organisations.

The ETF will have defined maturity period where you get your principal amount along with returns at the time of maturity . So , it is sort of FMP – Fixed maturity Plan . There are two bonds available right now maturing on April 2023 and April 2030 respectively .

The current yield to maturity (YTM) is 6.59% and 7.52% respectively . You can expect the returns close to this YTM at the time of maturity .

Pros :

  1. Safety : Since the bonds are from government companies mostly AAA rated bonds , the credit risk can be considered as almost zero . Please note that the Bond is neither Capital Protected nor Guaranteed Return Product.
  2. Cost : ETFs are generally much cheaper that normal mutual fund . The fund management cost of this ETF is 0.0005%.
  3. Since the ETF will track an index, the fund manager risk is zero .

Cons :

  1. Liquidity : We still do not have enough trading happening in ETF . The volumes are very low . Therefore , it will be difficult to sell the bond easily in case of liquidity requirement . Even if you get the buyer, you may have to sell at the discount in the secondary market .
  2. Interest Rate Risk : Since it is long term bond specially April 2030 , there is an interest rate risk because the interest rate and the bond prices are inversely related.When the interest rates go up, the bond prices go down. When the interest rates go down, the bond prices go up. And the extent of ups and downs depend on the duration (maturity) of the bonds. Longer the maturity, the higher the sensitivity.
  3. Demat account: One has to have demat account if wishes to invest into it . 

Taxation :

There is no interest income or payout from the bonds during the period of the bond . Interest is reinvested back to ETF , So you get the principal and gain amount at the time of maturity. Both the bonds are having more than 3 yrs of horizon , so it will qualify for long term capital gain which is taxed at 20% with indexation .  Click here to know more about indexation.

The current portfolio is as below

 

Nifty BHARAT Bond Index – April 2023

Issuer Credit Rating Weights
REC Limited AAA 15.02%
Power Finance Corporation Limited AAA 15.01%
National Bank for Agriculture and Rural Development AAA 14.98%
Housing & Urban Development Corp. Ltd. AAA 11.84%
Export-Import Bank of India AAA 8.00%
Power Grid Corp. of India Ltd. AAA 7.24%
Small Industries Development Bank of India AAA 7.01%
NTPC Ltd. AAA 6.65%
Hindustan Petroleum Corporation Ltd. AAA 4.87%
National Highways Authority of India AAA 3.86%
Nuclear Power Corporation of India Ltd. AAA 2.43%
Indian Railway Finance Corp. Ltd. AAA 1.88%
NHPC Ltd. AAA 1.21%
(Source : Edelweiss AMC , BharatBond.in)

Nifty BHARAT Bond Index – April 2030

Issuer Credit Rating Weights
Indian Railway Finance Corp. Ltd AAA 15.01%
Power Grid Corp. of India Ltd. AAA 15.00%
National Highways Authority of India AAA 14.99%
REC Ltd. AAA 12.73%
NTPC Ltd. AAA 11.64%
Indian Oil Corp. Ltd. AAA 8.00%
Nuclear Power Corp. of India Ltd. AAA 6.61%
Power Finance Corp. Ltd. AAA 6.51%
NLC India Ltd. AAA 3.92%
Export-Import Bank of India AAA 2.83%
National Bank for Agriculture & Rural Development AAA 1.48%
NHPC Ltd. AAA 1.27%
(Source : Edelweiss AMC , BharatBond.in)

PLEASE NOTE THAT THIS IS CURRENT INDEX CONSTITUTION. IT MAY CHANGE IN FUTURE.

Other details:

  1. The offer period is from 12 Dec 2019 to 20 Dec 2019 .
  2. The minimum investment amount is Rs 1000/- . Application up to Rs 2,00,000/- , it is under retail category and the application above Rs 2,00,000/- will be counted under non-retail category. Such categorisation will be applicable only during offering period. 
  3. The issue size of the 3-year Bharat Bond ETF is Rs 3,000 crores (with an option to extend it by Rs 2,000 crores.
  4. The issue size of the 10-year Bharat Bond ETF is Rs 4,000 crores (with an option to extend it by Rs 6,000 crores.
  5. Edelweiss AMC is managing the issue. Those who don’t have demat account , AMC is offering it through Fund of Fund (FoF) . However , the cost will go up .
  6. Non-resident Indians (NRIs) can invest in Bharat Bond ETF.

Should You Invest or Not ?

It is good for investors who are in 30% tax bracket and willing to block the funds for longer period with passive mode . Investors who are in zero or lower tax bracket should stick to traditional investment like Bank FD for liquidity , stability , regular payout if required .

Investors with time horizon of say 2 -4 yrs  should stick to debt funds with similar bond profile having fund maturity matching with their time horizon to avoid interest rate risk because these bonds would be more volatile .

Happy Investing !!!!!

Learn from it or Run from it….

By Nikhil Shah

People often think they can’t change their past, but I disagree. Perhaps we can’t change every mistake in our past, but we have to remember that the past is a moving target. Every day that goes by us becomes a part of our past history. Whatever we do today will become a part of our past tomorrow, which means we do have the power to change our past by doing the right things today.
This lesson is taught best in the Disney movie “The Lion King.” There is a point in the movie when the young lion Simba is feeling sorry for himself for his past mistakes. The wise baboon Rafiki takes a stick  and hits Simba on the back of the head. Simba yells, “Geez, what was that for” and Rafiki replies, “It doesn’t matter, it’s in the past.” Simba says, “Yeah, but it still hurts.” Rafiki then says “Oh yes, the past can hurt. But the way I see it, you can either learn from it, or run from it.Rafiki then swings the stick again to hit Simba on the head and Simba ducks down in time to avoid the stick. Rafiki says, “You see.”  I love that example! It’s the perfect reminder that this principle should not be a difficult one for us to grasp. Yes, it hurts to mess up, but it’s in the past, so learn from it and move on.

Loss-Aversion Bias in Investment Behaviour.

It explains why despite deciding you’ll hate a movie ten minutes in, you’ll stick it out for the whole two hours in misery. You’ve already paid for the ticket, so you don’t want to waste money by not seeing the movie. But you won’t get that money back if you stay, so why do you feel like you have to? The reason we’re inclined to throw good money after bad (which economists call the sunk cost fallacy) is a perfect example of loss aversion in action. If we’ve spent resources on something—whether it’s as small as a ticket to a bad movie or as large as the billions of dollars spent in a war or social program that’s not working out—we’re inclined to stay the course so as not to waste what we’ve already spent. In other words, we want to avoid feeling the loss of what’s been spent, so we stick with our plan, hoping for a gain, even when sometimes that just leads to a bigger loss in the long run.

Similarly, in investment products many times how it is beneficial by correcting mistakes.

Let’s understand by example case of Mr. Swami. who bought Traditional Endowment Insurance Plan.

Mr. Swami is dynamic Software engineer, at the age of 30, he decided to save for his Retirement Goal AND TAKEN Traditional Endowment Insurance Plan for 20 years premium paying term with 1 Lakh Annual Premium.

Mr. Swami was upset after seen 5 year returns of only 6.5% p.a.(CAGR) , Now, today at the age of 35 when he got his Financial Health Checkup done from an Advisor.

Advisor recommended him below “CHANGE”:

  • He asked him to stop paying further premium and get the policy paid-up first.
  • Get term plan for self which will cost very less in annual premium and high in life cover.
  • Start investing in Hybrid Equity MF or Diversified Equity MF for next 15 years period.


** Note: Above calculation is considered without taxation.

What have you done if you are at the place of Mr. Swami ?

There is no question that making mistakes is a necessary part of our growing process, but I do believe there is a way we can still learn and grow without making quite so many mistakes and in a way that can be far less painful. And when you do make your next mistake, which all of us most certainly will – own it, fix it, and for heaven’s sake when that stick comes swinging toward the back of your head, hopefully you have learned enough to duck like Simba !!

Happy Investing !!

Indexation and its benefits to Debt funds

By Nikhil Shah
With every financial year ending, your big task would be to calculate tax on income from sell of any asset you own (Real Estate, Shares, Mutual Fund, Gold, Debentures, Bonds). Tax applicable on any income from asset comes under head of capital gain. How Indexation works plays important role hear and its beneficial through Debt Mutual Fund let’s understand.
Concept of Indexation and role of CII Cost Inflation Index on capital gains tax calculation:

The value of rupee today will not stay the same for tomorrow. The prices keep increasing due to inflation. It is fair to pay more for toothbrush, restaurant bill, clothes etc. over the years because of the price rise due to Inflation. Likewise, it is not fair to pay Capital Gain Tax without incorporating the factor of inflation.
The government charges tax on our sale of the asset and they do not wish to let go of the capital gain. Hence, the government charges capital gains tax, which is calculated on the basis of CII.
Cost inflation index (CII) is an index issued by the Central Board of Direct Taxes and the figures keep changing every financial year.
In order to avoid paying a large sum towards tax, the sale price of the asset can be indexed to demonstrate the asset’s value as per its current value, taking into account inflation reducing its value. In this manner, the profit derived from the sale would be lower, thus reducing the capital gains payable.
Thus, indexation helps reflect the actual value of the asset at present market rates, taking into account the erosion of value due to inflation.
The CII for a particular year is fixed by the government and released every Fincancial Year(FY), for the purpose of tax computation.

Below is latest applicable CII (Cost of Inflation Index) chart:

The formula to calculate the cost inflation index is as follows:
Cost Inflation Index (CII) = CII for the year the asset was transferred or sold / CII for the year the asset was acquired or bought

Lets understand with practical case of with Fixed deposit Vs Debt Mutual Fund.

Mr. Parikh pro saving person comes under 30% tax slab.
He has done 2 Investments on same date and exited from them on same date.

Investment 1.

He invested in Bank Fixed Deposit Rs.1 Cr. at annual rate 8%, in Jan 2014. He exited from it for Rs. 1.24 Cr. in Jan 2017.

Computing tax for this investment is as below:
The Interest income = Exit value of Fixed Deposit – invested value of Fixed Deposit.
i.e., 1,00,00,000 – 1,24,00,000 = Rs. 24,00,000

His Net Interest income is Rs.24 lakhs in absolute term.

Tax liability is charged at 30% tax slab. The tax liability will be 24,00,000 X 30% = Rs. 7,20,000
Net Income in hand = Rs. 16,80,000  i.e., 24,00,000 – 7,20,000.

Investment 2.

He invested in Debt Mutual Fund Rs.1 Cr. at annual rate 8%, in Jan 2014. He exited from it for Rs. 1.24 Cr. in Jan 2017.

Computing tax for this investment is as below:
First we have to calculate CII by this formula.

Cost Inflation Index (CII) = CII for the year the asset was transferred or sold / CII for the year the asset was acquired or bought

The CII for the Jan 2014 FY in which Debt Mutual Fund was 220. The CII for the Jan 2017 FY mutual fund redeemed was 264.

The Cost Inflation Index (CII) is 264/220 = 1.20

While computing tax, CII is multiplied with the purchase price to arrive at the indexed cost of acquisition. This is the actual cost of the asset.
Therefore, the indexed cost of acquisition = 1,00,00,000 X 1.20 = Rs. 1,20,00,000

The long term capital gain= sale value of the asset – indexed cost of acquisition
i.e., 1,24,00,000 – 1,20,00,000 = Rs. 4,00,000

Tax liability by indexation method charged at 20%. The tax liability will be 4,00,000 X 20% = Rs 80,000

Below table will help you to understand it more clearly.

* In both Investments tax calculation surcharge and Education Cess is not considered. 
When you index, it helps you save taxes. It helps you adjust the purchasing price of the Debt Mutual Fund with the current market prices.

What is capital gain?
When you sell any asset you own (Real Estate, Shares, Mutual Fund, Gold, Debentures, Bonds are treated as assets) and you make a profit on the sale, it is known as capital gain. The tax you pay on profit earned is called as capital gains tax.
No tax if you make a loss (you sell at a lower price than you bought it), you incur a capital loss.

What are the types of capital gains on Debt Mutual Funds ?
Depending on how long you held the Debt Fund, the capital gain is classified either as short-term or long-term.

Note: In above case provided investment is in Debt Mutual Fund – Growth Option. In case of dividend option of Debt Mutual fund, Dividend Distribution Tax will be applicable as per given rate by govt. We will cover Dividend Distribution Tax in separate blog.

Short-term capital gain: Applicable if you sell the Debt Mutual Fund within 36 months from the date of purchase.
In traditional products such as fixed deposits or debentures, the interest on your investment is taxed as per your slab rate; that is –whichever tax slab you fall under. With debt mutual funds too, your gains (short-term gains) are taxed as per your slab rate if you held them for less than 3 years or 36 months.

Long-term capital gain: If you sell the Debt Mutual Fund after 36 months from the date of purchase.
After crossing 3 Years or 36 months in Debt Funds, method of tax calculation as per Indexation is game changer. And in traditional products it remains same as per tax slab of individual.

Income earned on traditional products is treated as Interest income under Head of Income from other sources.
However Income earned on Debt mutual fund is treated as capital gain under Head of Income from capital gain (Mutual funds are treated as Assets).

In above comparison table you can see how Mr. Parikh got benefited higher net income by paying low tax through the route of Debt Mutual Funds compared with low return by paying higher tax on Fixed Deposit.

Liquid Funds – An Excellent Alternative to Savings Account

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Keeping money in the savings account or short term FD’s are the easiest way to invest the surplus funds but may not be the smartest . We all have some expenses coming yearly / half yearly / quarterly or may be monthly like school fees , insurance premiums ,  house taxes & maintenance , vacations etc in case of individuals and different taxes , short term payments in case of companies . Such funds are lying idle either in savings / current account or short term FD’s .  The post tax effective returns on savings account and short term FD’s are much lower as compared to liquid funds .

What are Liquid Funds?

Liquid Fund is a category of mutual fund which invests primarily in money market instruments like certificate of deposits , commercial papers , treasury bills and term deposits.

Certificate of Deposits : Financial institutions like banks need short term funds for various reasons . So , they raise money from the market which are called certificate of deposits .

Commercial Papers : When public and private companies need short term funding , they raise money from the market which are called Commercial Papers.

Treasury Bills :  We all know that Government borrows funds by issuing  long term bonds . Similarly , when they need money for short term says 30 – 90 days or so , they raise it from the market which are called Treasury Bills .

Bascially, liquid funds park their funds with banks , government and companies for short period ( mainly below 90 days ) .

Please refer the returns for 1 month , 3 months , 6 months and 1 year of CRISIL Liquid Fund Index as below. You can see the line which is heading upward and always above zero in all periods .

Fund 1m 3m 6m 1yr
Index : Crisil Liquid Fund Growth 0.66 2.05 4.21 8.6
1 month Return
1 month Return
3 months return
3 months return 
6 months return
6 months return
1 year return
1 year return

Please find the comparison of liquid funds with SBI Savings account , SBI short term FD rates for 60 & 180 days .

Comparison SBI Saving A/c SBI 60 days FD SBI 180 days FD Liquid Fund
Amount invested 10,00,000 10,00,000 10,00,000 10,00,000
Period (months) 2 2 2 2
Annualised Returns 4% 6.75% 7.25% 8%
Amount after 2 months 6,667 11,250 12,083 13,333
Returns for 10% Tax Bracket 6,000 10,125 10,875 12,000
Returns for 20% Tax Bracket 5,333 9,000 9,667 10,667
Returns for 30% Tax Bracket 4,667 7,875 8,458 9,333

Features and Benefits of Liquid fund 

  • No Entry and Exit load .
  • No Lock in period
  • Easy liquidation ( Hence the name ) .Funds can be redeemed within 1 working day.
  • Great tax benefit

In a nutshell , give a wake up call to your idle fund and let it work for you .

Happy Investing !!!

Time to play duration game

For the past few months, we have been emphatically suggesting to build exposure to long duration. While RBI preferred to stay focused on inflation over growth side in its last monetary policy, we at Pentagraph, still feel confident about the rate cut in coming quarters and suggest building an exposure to duration strategy funds along with accrual strategy funds.

We have taken the latest data on Govt Borrowing.

Government Borrowing Programme (Rs.   Cr.)
Budgeted   G-Sec Gross Borrowings for 2011-12 569616
Budgeted   G-Sec Net Borrowings for 2011-12 479000
Budgeted   Redemptions 90616
G-Sec   Gross Borrowings till Date 422000
G-Sec   Gross Borrowing Completed (%) 74.09%
Maturities   till date 85615
Net   G-Sec Borrowings till Date 336385
364 Day   T-Bill Gross Borrowings till date 80000
OMO   Purchases till date 54573
SDL   Auction till date 97490

Source: http://www.stcipd.com

 It indicates that Government Bonds are likely to outperform in coming year.Our reasons for expecting this are as follow

  1. Most of the Budgeted G- Sec borrowing is completed .
  2. The RBI is also likely to conduct more OMO bond purchases worth Rs. 60,000 crore to 1,00,000 crore in the second-half of the year to support systemic liquidity and growth.
  3. State Development loans (SDL) which are issued by the state governments directly and count as SLR securities are quoting at 9 – 9.05% levels on annualized yield basis. As against this, 10 year AAA corporate bonds like REC and PFC are quoting at approximately 8.95% levels. These levels are not likely to sustain for a long time and bound to see correction.
  4. Most Important , Government is guiding to bring fiscal Deficit down by adopting different strategies & reform and hinting RBI to lower the rates subject to their inflation expectation.

Therefore , The debt fund running overweight on Government Bond exposures will do better if governement bonds yield fall. The duration funds like income / dynamic bond funds would be better choice to grab this opportunity keeping one year horizon .