×
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT

Bonding with investments

Last Updated 09 December 2019, 02:13 IST

Recently there has been a debate on the upcoming PSU Corporate Bond ETF – Bharat Bond ETF - units of which are to be issued and managed by Edelweiss Asset Management Company.

While we are all familiar with Bonds, the space has become somewhat complicated with issuers defaulting or delaying payments. The real impact of such events has been felt recently with the ongoing credit issues with companies and NBFCs’. It is complicated because we are yield-hungry and yet have little public knowledge of the kind of risk in bonds in which we invest.

So what is the risk in a bond? Any bond carries with it two types of risk - the first is credit risk – which is the inability or unwillingness of the issuer to default on or delay the payment of the coupon or the principal on the bond. The second is the interest rate risk i.e. bonds tend to become less attractive as interest rates rise.

At one end of the spectrum is government debt (GSEC/GILT or other bonds issued by the government / Reserve Bank of India) – this is a credit risk free investment as the mode of repayment (Rupees) can be printed in (theoretically) unlimited quantities (fiscal/monetary prudence aside) to repay bondholders whenever the need arises. However, these aren’t ‘risk’ free as the prices of these bonds will move in conjunction with interest rates and overall demand and supply of different bonds.

Therefore ‘Gilt’ Funds see significant movement in Net Asset Values (NAVs) when there are RBI policy announcements or there are interest rate movements.

Corporate Bonds (including PSU and the likes) on the other hand have somewhat different dynamics – these carry both interest rate risk as well as credit risk as said companies (or other bodies) do not have the ability to print money and must necessarily rely on cash-generating activities to repay their bondholders. Banks are included in corporate bond issuers.

Technically Public Sector Undertakings are Limited Liability companies and have the government as a majority or significant shareholder, carrying with it government backing for business (preferential treatment like HAL or NHAI) and cash flows (Air India).

Bharat Bond ETF therefore is a corporate bond ETF which will be subject to the vagaries of corporate bonds i.e. Credit Risk, Interest Rate Risk as well as price movement based on demand and supply (illiquidity premiums – extra money you pay for something that trades infrequently).

The question therefore is should you invest? And the short answer is: It depends on a few factors: liquidity on the exchange, credit spreads (or absolute yields) and whether an FMP style Bond ETF fits in the strategic allocation.

Liquidity: this gives the investor the ability to exit the investment on demand, whether it is to book profits, stop loss, or shift in strategic (or even volatility) allocations. Credit spread is the premium you get over a similar maturity Dated Government of India Security (GSec) issued by RBI - a PSU or a Corporate bond yielding a return like a similar maturity GSec would be unattractive. And last but not the least demand and supply – largely determined by the above two factors.

ADVERTISEMENT
(Published 08 December 2019, 14:34 IST)

Follow us on

ADVERTISEMENT
ADVERTISEMENT