It's straightforward to comprehend where and how equity funds invest and generate returns. They acquire and dispose of equity securities. When stock prices increase, equity funds often benefit.
However, debt markets operate differently. Described, it is a marketplace for borrowers seeking to borrow money and lenders wanting to lend. It is critical to make interest and principal payments on time. And because individual investors are frequently unable to purchase them directly (the face amount of a bond is generally about Rs 1 lakh), there is a lack of information regarding how much debt products work.
Treasury bills Repurchase (TREPS) stands as a brief money market tool enabling investors to garner returns on unused cash. Mutual funds, a favoured investment avenue, engage in TREPS to yield profits for their stakeholders. This discussion delves into the rationales driving mutual fund investments in TREPS and the ensuing impact on their share values.
TREPS, a short-term financial tool utilized by institutions, banks, and mutual funds, involves one party vending a treasury bill to another with a commitment to repurchase it later at an agreed-upon price. Renowned for safety through government-backed securities, TREPS present appealing returns and swift liquidity, making them ideal for short-term investor horizons. Additionally, SEBI requires mutual funds to set aside at least 5% of their assets for liquid assets, ensuring the inclusion of TREPS.
Why Do Mutual Funds Invest in TREPS?
Mutual funds choose to invest in TREPS for several reasons, encompassing safety, liquidity, appealing returns, and regulatory adherence. The safety aspect stems from the involvement of government-issued securities, instilling confidence in mutual funds regarding the security of their investment. TREPS also stand out due to their quick liquidity, making them an optimal choice for mutual funds seeking short-term placement of idle cash. Furthermore, the allure lies in the attractive returns compared to alternatives like savings accounts or fixed deposits, with returns linked to market conditions, offering higher yields in times of elevated interest rates. Regulatory obligations, particularly from SEBI, necessitate mutual funds to allocate at least 5% of their assets to liquid assets such as TREPS.
The impact on a mutual fund's share price resulting from TREPS investment depends on factors like investment size, duration, market conditions, and portfolio composition. On one hand, it can elevate share prices by enhancing the net asset value (NAV) through higher returns, while on the other, a substantial and prolonged TREPS investment may dampen the overall portfolio's return potential, potentially lowering the mutual fund's share price if perceived as less lucrative by investors.
Benefits of Investing in TREPS
- Security in Government-Backed Securities: Choosing TREPS provides a safety net by requiring the purchase of government-issued securities. This feature boosts investors' trust by ensuring the security of their assets.
- Swift Liquidity for Short-Term Gains: TREPS offer quick liquidity, making them highly accessible in the money market. This attribute makes TREPS an optimal choice for investors looking to park idle cash for short durations, facilitating ease of buying and selling.
- Attractive Returns Aligned with Market Conditions: The returns on TREPS are dynamic, responding to prevailing market conditions. Particularly advantageous during periods of elevated interest rates, TREPS offer investors the opportunity to earn higher returns on their idle cash.
- Adherence to Regulations to Boost Investor Confidence: Regulatory authorities like the Securities and Exchange Board of India (SEBI) require the incorporation of TREPS in the liquid asset composition of mutual funds. This way regulatory compliance, instilling confidence in investors is ensured. Investors are then relieved that their mutual fund investments align with established regulatory guidelines.
- Diversifying Your Portfolio for Risk Management: Investing in TREPS helps you to diversify your portfolio by providing a stable and liquid choice. This diversification technique significantly reduces the total risk of the portfolio, guaranteeing you stability even amid market volatility.
What types of investments do short-term debt funds make?
Banks, non-bank financing companies (NBFCs), public sector entities (PSUs), enterprises, and the government issue these money market instruments to cover their short-term funding needs. Typically, such funds invest in instruments with a one-year maturity. TREPS (Tri-Party Repo), repurchase agreements (repo), Certificates of Deposit (CDs), Commercial Papers (CPs), and T-bills are only a few of the instruments available.
Repo and TREPS are used to make loans for brief periods, such as overnight or up to a year. Repo enables banks and non-bank financial companies (NBFCs) to borrow money by pledging government securities as collateral. Additionally, these organizations can lend in the repo market. Surprisingly,
mutual funds are limited to lending in the repo market (barring extreme conditions).
The RBI recently permitted repos to be collateralized by corporate bonds to revitalize the debt market.
Surprisingly, even
equity funds use the repo market to store short-term excess liquidity.
Additionally, short-term
debt funds invest in certificates of deposit, commercial paper, and Treasury bills. Additionally, they are mechanisms that let borrowers – banks and corporations – to borrow money for short-term purposes. Banks issue certificates of deposit, corporations issue certificates of participation, and the government issues T-bills through the RBI. CDs are often rated higher than CPs and have a higher credit quality. Additionally, this is why CPs have somewhat higher interest rates to compensate for their occasionally poorer credit rating.
The majority of these products are zero-coupon bonds issued at a discount. For example, a three-month
T-bill with a
face value of Rs 100 may be issued at Rs 98, a saving of Rs 2. The issuer repays the face amount of Rs 100 upon maturity. Thus, the investors receive a return of Rs 2.
While short-term debt funds devote a sizable amount of their assets to such investments, long-term debt funds also devote a sizable portion. However, as the graphic indicates, short-term debt instruments offer significantly smaller yields.
Where do long-term debt funds make their investments?
Government securities are the safest long-term instruments (g-secs). The central government needs finances to operate daily and finance the fiscal imbalance. Apart from other sources of financing such as taxation, it also borrows money from the debt markets via the RBI, its banker, by issuing g-secs. Additionally, state governments borrow through the issuance of State development loans (SDLs).
G-secs can have maturities of up to 40 years. These instruments are the safest and most liquid since the state guarantees them back. G-sec mutual fund schemes invest primarily in these gilt securities. However, other debt and hybrid funds also hold g-secs to control their credit mix duration (interest-rate sensitivity).
Bonds and Debentures
Similarly, they issue
bonds and
debentures when businesses want long-term financing. These are available in terms ranging from one to fifteen years. However, corporate bonds are not backed by the government (unlike g-secs and T-bills), so they entail a more significant credit risk. Additionally, they pay higher interest rates to compensate.
As a result, bonds also have credit ratings. Unless you invest in a credit risk fund, choose bonds that invest a significant portion of their assets in highly rated securities. Generally, government-owned enterprises' bonds are deemed safer than those issued by private companies; however, this is not always the case.
Notably, short-term debt funds also invest a portion of their assets in G-Secs and bonds with a short residual maturity, typically less than a year.
Securitized debt instruments are securities created through the securitization of individual loans.
Simply put, a bank has a Rs 1000 crore vehicle loan portfolio. To raise capital, the bank generates debt instruments (known as pass-through certificates or PTCs) backed by the underlying asset, the vehicle loan portfolio, and sells them to mutual funds and other investors.
Technically, a securitization transaction comprises the originator (the bank) selling receivables to a Special Purpose Vehicle (SPV), often structured as a trust. Investors (mutual funds) are issued rated PTCs, with the proceeds paid to the originator as recompense.
Rating agencies assign ratings to these securitized debt securities. Mutual funds seek to invest in only AAA-rated companies.
The risk associated with investing in securitized debt is comparable to that of investing in debt securities. In January 2019, many debt funds managed by Aditya Birla and HDFC mutual funds were impacted after the SPVs of two IL&FS-owned road projects that they held defaulted on interest payments.
Several mutual fund schemes invest between 0.2% and 10% of their portfolios in these products.
Among the hazards associated with debt, funds are interest rate risk (sometimes referred to as duration risk, market risk, or volatility risk) & credit risk (also known as default risk). What we will describe is not so much a new risk management discovery as it is evolving in the current state of the debt market.
Apart from the credit rating, another indicator of a debt fund's soundness is the month-to-month change of the portfolio corpus size. If the fund's corpus is continuously and considerably shrinking, the fund is under strain. If the corpus size is not consistent, a small amount of negative CA in the portfolio (say -2 or -3 per cent) is not a problem. Additionally, a healthy CA surplus fund is better positioned to withstand any redemption pressure. Because liquid funds undergo redemption pressure in March due to corporate advance tax payments, they should not be rated solely based on March outflows. For portfolio size changes in other debt fund categories, the observation period should be more extended, say the previous six months. Corpus fluctuation is minimal for funds with a high-quality portfolio, and you may remain invested.
This article should give you a good idea of
treps in mutual funds and treps investment in mutual funds.
Mutual Funds Calculator
