Taking A Closer Look At The Indian Bond ETF

New funds in emerging markets are launching all the time, but it’s worth looking under the bonnet

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Reviewed by: Emma Smith
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Edited by: Emma Smith

The allure of high returns matched with the prospect of volatility and a hefty dose of risk continue to draw steely-nerved investors to emerging markets.

Record low interest rates in developed countries are spurring investors to seek higher returns from increasingly exotic assets, with exchange traded funds (ETFs) serving as a low-cost, liquid and transparent vehicle for access.

Since the UK bank rate was anchored at 0.5 percent in 2009, investors have poured cash into emerging markets. ETFs providing exposure to these regions saw the second largest inflows of an equity asset class in October, at $5.2 billion, according to ETFGI.

More ETFs providing focused, targeted exposure to asset classes within emerging markets are launching, but come with a set of risks and are not for the faint-hearted. Among the latest is the world’s first Indian bond ETF, the ZyFin India Sovereign Enterprise Bond UCITS ETF, which launched in November on the London Stock Exchange.

Shaun Port, chief investment officer of wealth manager Nutmeg, said: “For us as asset allocators, it’s great to see new asset classes becoming available in ETF format.”

More Yield Means More Risk

With regards to the new Indian bond ETF, launched by Indian macro-analytics firm ZyFin and British company Sun Global Investments, Port said the ETF “certainly has appealing risk/reward characteristics,” given the yield premium over other AAA-rated debt.

While the yield is attractive, Nutmeg’s Port also likes the security of state ownership, as the ETF tracks a basket of Indian public sector corporate bonds.

Sanjay Sachdev, executive chairman at ZyFin, said in a statement when the fund launched: “We are excited to taking the pioneering step of offering India’s first physically backed fixed income ETF and providing an opportunity for global investors to access India in a transparent and cost-effective manner.”

However, there is always a higher element of risk with new funds tapping niche asset classes, with no performance history from which to draw. Port notes that as this product is the first of its kind, there is some uncertainty over how well it will perform.

“The product also tracks an index owned by the issuer, with only six constituents – meaning it is highly concentrated,” Port warned.

Investors might also be wary of other risk factors, such as currency. At present, the new fund offers no hedged share classes. With the base currency of the ETF in dollars, UK investors are taking rupee/US dollar risk as well as US dollar/sterling risk.

 

No Successful Precedent Flags Risks

Adam Laird, passive investment manager at Hargreaves Lansdown, warned that liquidity could prove to be problematic. He points to the fact that another asset manager UTI attempted to launch an Indian bond fund last year, but this was delayed due to Indian government debt quotas being almost totally utilised.

The postponed launch flags the regulatory risks surrounding government quotas and limits potentially affecting this asset class.

“This is obviously a very niche market, a very specialist area, so it is going to be difficult to trade…it’s going to probably be very illiquid,” said Laird.

In spite of the risks, experienced investors could find the allure of an untapped market in a globally growing and important country very attractive.

India accounts for around one sixth of the global local currency emerging market debt index, Laird pointed out. The country has also been cutting interest rates – four times this year –which tends to raise bond value. Indian 10-year government bonds also yield about 7.7 percent, compared with the UK 10-year gilt yielding 1.9 percent.

The inherent risks are high, but the rewards could be plentiful, for investors seeking to tap the growth story of India and other key countries within the region.