Thread by @avasthiniranjan

Understanding the risks in #BHARATBond ETF and how do you mitigate them.

Any market link investment product has some risks attached to it. Some carry higher risk while some carry relatively lower risk. BB ETF falls in the latter category where risks are relatively lower.

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1. Price risk - this risk comes from fluctuating bond prices due to changes in interest rates. Rising interest rates leads to fall in bond prices and falling interest rates leads to rise in bond prices. BB ETF NAV may fluctuate due to such rising or falling interest rate.

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However, this fluctuation in NAV shall not affect you if you are holding BB ETF till its maturity. It will affect only if you exit your investments before maturity leading to higher or lower returns.
Also, such fluctuation reduces significantly as ETF approaches its maturity.

Why risk reduces as you approach maturity?
Bond prices are more sensitive to interest rate changes when its maturity is far away and reduces as maturity comes closer. Means 3 yr BB ETF will have much lower price risk than 10 yr BB ETF. And risk in 10yrETF will reduce every year.

One way to mitigate price risk is to match your investment horizon with the ETF tenor. If you want to invest for 3 years then go for 3 yr BB ETF and stay puy till maturity. If you want longer horizon then go for 10 yearETF. Remember 10yr ETF NAV will fluctute more in initial yrs.

2. Default or downgrade risk - this risk is more worrying, thanks to recent credit crisis. This risk comes from any default or rating downgrade of bonds. In such cases price of bonds fall.
But relax, BB ETF invests in relatively safer bonds - AAA rated PSU Bonds.

While this risk remains even in AAA PSU Bonds as technically they also may get downgraded if not default. Default probability in such bonds it next to zero as they are quasi sovereign. I don't remember any AAA rated PSU bond defaulting in recent decades.

Why PSU Bonds are relatively safer -
As per CRISIL analysis no AAA PSU bond in the index in last 5 years have been downgraded to even AA+. Even in the worst credit environment of our times that we have seen in last 2 years none of these bonds have been downgraded.

ETF being a passively will exit such bonds even if there is one notch downgrade from AAA to AA+ and won't wait till the rating is downgraded further. I such a scenario there can be a price impact on the NAV. But going by history of PSU Bonds this risk is relatively low.

So be familiar of these risks while investing in BB ETF.

Happy Investing!