Liquidity in Bharat Bond ETF

Bharat Bond ETF works as a combination of mutual funds and stocks. Like mutual funds, it pools the money from the investors and invests in a broad mix of corporate bonds. Just like stocks, it, generally, trade on an exchange during market hours.

ETF operates in two markets with different types of market participants. Most of the trading happens in the secondary market, where investors buy and sell the existing ETF units, the price of which is determined in real-time. Similar to stocks, transaction costs are affected by its bid/ask spread. The more liquid the ETFs are, the lower is their transaction costs. This is generally due to tighter spreads.

This ETF also operates in the primary market that usually involves large investors or institutions viz. authorized participants (AP), who deal with ETF issuers to create or redeem ETF units based on the market demand. In terms of volume, ETF trading in the primary market is way less than that of ETF trading in the secondary market.

The structure of ETF is such that it can trade like both, closed-ended and open-ended funds. Existing ETF units can change hands between buyer and seller in primary or secondary markets without even touching the underlying securities. However, unlike mutual funds, there are three layers of liquidity in an ETF viz. the primary market, the hidden secondary market, and the visible secondary market.

Visible secondary market liquidity
The secondary market liquidity is said to be visible when buying and selling happen on the exchange during market hours. Generally, the higher the number of ETF unitholders better is the visible secondary market liquidity. Bharat bond ETF is said to have a large size that is spread across lakhs of investors, leading to high trading activity. As a major chunk of ETF trades are done in the secondary market, the liquidity of ETFs would not be overly dependent on its underlying securities during normal market conditions.

Hidden secondary market liquidity
AP are sometimes referred to as designated market makers (DMM) as well. These are the financial institutions that dynamically manage the creation and redemption of ETF units through an asset management company (AMC) to provide additional liquidity in the secondary market. These market makers provide liquidity by buying/selling ETF units and try to keep bid/ask spreads closer to the fair value of the ETF, which is represented by iNAV during the day. To ensure high liquidity in Bharat bond ETF on the exchanges, Edelweiss AMC is said to appoint APs.

Primary market liquidity
The third level of liquidity is via the AMC. Here, investors can create or redeem ETF units above specific basket size (Rs 25 crore) directly. This will provide large investors with seamless access to the redemption and creation of ETF units. When AMC will receive a redemption request, it will sell the underlying bonds and extinguish the units. On the other hand, when AMC will receive fresh investments, it will create new units by buying the underlying bonds from the market.

Hence, the liquidity would not be a major concern for investors, as Edelweiss has taken care to provide it via its three levels of liquidity. On December 20, 2019, the new fund offer (NFO) was closed for subscription and it is expected to list on exchanges by December 31, 2019.