The first Indian bond exchange-traded fund (ETF) has been launched on the London Stock Exchange. This gives investors exposure to the debt of state-owned Indian companies, but its high concentration in highly traded, potentially politically sensitive bonds make it a risky investment.
The LAM Sun Global ZyFin India Sovereign Bond UCITS ETF (CRRY) offers exposure to a basket of Indian public sector stocks majority owned by the government of India, so-called sovereign owned enterprises (SOEs). The bonds - usually issued debt of transport, utility and infrastructure companies - are denominated in rupees and are AAA rated because of their long contracts with the Indian government, which secure them long-term income streams. Until now it has been impossible for UK investors to gain access to Indian corporate bonds denominated in rupees apart from in the form of Masala bonds - individual company bonds.
Gaining exposure to emerging markets via bonds is appealing - corporate bonds offer predictable income streams and exposure to foreign currencies, as well as access to markets usually off limits to investors.
But investors could be consuming heat with this CRRY bond fund that not even a litre of raita could cool. The main issue with the ETF is its concentration in just six securities. Adam Laird, passive investment manager at Hargreaves Lansdown, says: "Six is a very big individual investment risk."
The fund is split between six 16.7 per cent weightings to three utility and energy companies, one telecommunications stock, a power grid corporation and the Food Corporation of India. Shaun Port, chief investment officer at Nutmeg, says: "The index is highly concentrated, and capacity could become an issue for the strategy."
When the method of index selection is considered, the risk looks even higher. The ETF is made up of the six most liquid bonds of the Indian state-owned companies every month based on trading volumes. But that means you could end up holding the most heavily sold bonds from the previous month, in other words the least popular bonds.
Mr Laird says: "Everyone might dump these bonds if problems come along, then you're holding the investment a long way away while everyone who's closer to it and more dialled into the situation might be selling it."
Sanjay Sachdev, executive chairman at Indian data company ZyFin, which has devised the index with Sun Global, says "for every seller there is a buyer" and insists that when it comes to bonds, liquidity is king. To be included in the index, the bonds have to have an AAA rating, the correct maturity profile and a good yield - the average portfolio yield is higher than Indian sovereign bonds, at 8.23 per cent.
According to Mihir Kapadia, chief executive of Sun Global Investments, the risk of the companies on offer is so small as to be negligible. "The companies are all extremely profitable, so none of the companies have much risk at all," he says. "The credit risk is almost impeachable. There has never been a default (of a similar company) in 40 years and the government of India's ownership will never be able to fall below 50 per cent."
But there is political risk associated with investing in heavily state-regulated enterprises in emerging markets, which can be subject to sudden regulatory changes which hit state-owned entities. David Liddell, founder of IpsoFacto Investor, says: "It is slightly worrying that the companies are controlled by the state. Indian politics can be a bit murky and, although with these stocks you do have a quasi-guarantee of income, you never really know what could happen."
Another key risk comes in the form of currency exposure. Mr Port says: "Investors are effectively buying the rupee, which could have a big impact on returns. We think the rupee is quite overvalued, so currency losses could overwhelm the benefit of higher yields, and we are not convinced yet that the decline in broad emerging market currencies is at an end."
There are positive aspects to this ETF. Its yield is far higher than comparable AAA securities and the long-term government contracts offer a steady and predictable income stream. It is also a good way of adding diversification to an emerging markets portfolio. Mr Laird says gaining exposure to the rupee is actually a major benefit of this product.
But this is the first fund of its type in the UK and the first ETF index for data company Zyfin, too. Mr Liddell says: "This seems like a trail best blazed by institutional investors rather than retail investors."
