If you are wondering what a bond ETF is and how it works, then you have come to the right place. The idea is not rocket science.
Once you know the finer nuances of how a bond ETF works, then you could make an informed decision on whether to invest in these funds.
What is a bond ETF?
Bond exchange-traded funds are simple funds that invest in bonds of various kinds. These funds are traded on stock exchanges. Hence, they are called Bond Exchange Traded Funds or ETFs.
Bond ETFs can hold instruments and bonds of different corporate entities depending on the mandate of the fund. The offer document will define which corporate bonds will comprise of the bonds that are on offer.
How do bond ETFs work?
Bond ETFs essentially invest in bond paper of corporates. When companies want to raise debt liabilities, they can either borrow from banks or issue bonds. An ETF can subscribe to these bonds.
However, note that as all ETFs have to follow a benchmark indice on the exchange, the bond ETFs will also benchmark itself to an index.
How does the maturity profile of the bonds look like?
Depending on the mandate of the fund, a bond ETF could either have a fixed maturity or be a long-term bond fund.
When Bond ETFs have a fixed maturity profile, the bonds held by the fund mature at the same time the fund winds up. For example, if the tenure of the bond fund is around 5-years, then then maturity profile of the fixed income instruments that bond funds hold will also be around five years.
But how is a bond ETF different than a fixed maturity plan?
A bond ETF will be traded on the exchange and investors can buy and sell units on exchange on a real-time basis. In that sense, a bond ETF provides some liquidity.
On the other hand, investors in an FMP have to hold the FMP till maturity as it is a closed-end structure.
How can I invest in Bond ETFs?
Investors can either participate in these funds during the offer period or buy these funds from the stock exchanges after it is listed.
Once you buy these funds, the units are then credited into your demat account. As such, investors may need to have a brokerage or a demat account.
Can I invest in bond ETFs without a demat account?
The other alternative for investors in bond ETFs is to invest via fund-of-funds that invest in bond ETFs. A fund-of-fund is a structure when one fund invests in the schemes of another fund or a variety of funds.
Investors investing through the fund-of-fund route will not require a broking or a demat account. However, there is a cost involved when you go through a fund-of-fund route.
How do investors make money in a bond ETF?
As such, investors can make money through the increase in the net asset value of the bond held in the funds. Over time, as the interest accrues on bonds held in the ETF, the value of the funds will increase. That would tend to increase the value of the Bond ETF.
