The Mutual Fund Show: Should Indian Investors Consider U.S. Treasury Bond ETFs?
Such an investment is for a discerning clientele that understands the U.S. bond markets, say experts.
Two new fund offers by Aditya Birla Sunlife Mutual Fund focus on U.S. Treasury bonds. It is a unique idea and meant for a discerning clientele that understands the U.S. bond markets, according to experts.
The exchange-traded funds are of varying duration, spanning one to three years and three to ten years.
"It is for a very, very particular segment, which wants a fixed income allocation in the highest possible safety asset available globally," Mohit Gang, co-founder and chief executive officer of Moneyfront told BQ Prime.
According to him, the idea behind the funds is to play in three parts—static yield of the bond, game of capital appreciation, and currency play.
An investor's return expectations have to be fairly tepid—between 4% and 8%. "If you are really lucky, you might just end up on the higher band of this range, or maybe a little higher if all three factors—the currency, rate cut and yields—work for you," he said.
There is an expectation of rate cuts in the near future by the U.S. Federal Reserve from the multi-decade highs currently. "This could present an opportunity for the investor to lock in at a higher rate and take advantage of the capital gains possibility," said Nisreen Mamaji, founder of MoneyWorks FS.
U.S. benchmark 10-year yield crossed 5% first time since 2007 as Fed keeps rates elevated to contain inflation. As a result, the dollar has further strengthened.
Investments in the treasury bonds acts as a hedge against weakening of the rupee. For this kind of product, there is neither any capping of amount as under the Liberalised Remittance Scheme route, nor any applicability of tax collected at source, she said.
Risk Factors
The risks in such investments are threefold. "If the rate cycle doesn't reverse, if the yields go up further, if the U.S. dollar doesn't appreciate that much. I think those risks have to be accounted for," Gang said.
An investor could be subject to interest rate risk, inflation risk, and general market fluctuations.
"It also exposes the investor to the currency risk, if it goes the other way around and not according to your expectations. If the interest rates move differently, then you will be seeing a lower return because there is an inverse proportion relationship between the yield and the coupon rates," Mamaji said.
Helios Flexi Cap Fund 'Merits Attention'
According to Mamaji, funds such as the Helios Flexi Cap Fund could be interesting to investors, "because typically a flexi-cap will have a large-cap bias, and tactical allocation will be in the mid or a small-cap category".
An investor should also keep a five to seven-year horizon in a flexi-cap fund to let it perform to meet financial goals, she said.
Gang said the fund "merits attention" given the pedigree of the fund manager Samir Arora, who has "an impeccable record".
"He is, in fact, the longest serving fund manager—if you take the Indian mutual fund industry—the oldest and the longest ... On the track record side, I think they (Arora and Dinshaw Irani) have an established pedigree," he said.
Watch the full interview here:
Edited Excerpts From The Interview:
Mohit, everybody's talking about yields in the U.S. Is there a way for Indian investors to take advantage of that? Aditya Birla Sunlife has launched two new funds offers—the U.S. Treasury 1-3 Year Bond ETF Fund of Fund and the 3-10 Year Bond ETF Fund of Fund. What are these products? What kind of investors are they suitable for, if at all?
Mohit Gang: I will go with the Aditya Birla U.S. Treasury Fund first. It is a very, very unique idea. It is especially meant for very sophisticated, savvy clientele who understand not just the debt market, not just the bonds and the yields, but also the U.S. bond markets and have been studying them, and have been watching the U.S. Treasury yield. So, it is not for everyone.
First and foremost, it is for a very, very particular segment, which wants a fixed income allocation in the highest possible safety asset available globally and why I say that is, because the underlying holdings of the fund will be U.S. Treasury investments, U.S. Treasury bonds. And U.S. Treasury, as all of us know is considered the safest instrument globally, being rated AAA globally. They got downgraded by a couple of agencies of late and are now AA+ but still, U.S. has never defaulted on its bonds. So, if you want one safest parking instrument for your money, I think that is there.
But the whole idea out here is to play in three parts. One is, obviously the static yield of the bond. The U.S. Treasury is at its highest level since 2007. Ten-year Treasury yields are at around 4.8%, 4.83%, and at their highest that we have seen in the last 15 years or 17 years may be.
Second, your static yield is fairly high on the three to 10-year portfolio, which Aditya Birla is quoting right now somewhere in the range of around the same range—4.8% to 4.4%. The second is the game of capital appreciation. Now, all of us are anticipating that the rate cuts will start happening fairly soon. Whether it happens this financial year in the U.S. or it spills over to the next, but in next three years, the rate cycle will reverse full swing. And, there are early signs of where the Fed is going little dovish in its commentary of late and perhaps maybe one more rate hike but if not. Then yes, you can anticipate a rate reduction cycle happening from next year, which will mean a whole lot of capital appreciation.
A 100 bps reduction on a 10-year Treasury paper with a modified duration of around six years could be almost like a six-to-seven-year kind of capital appreciation on the portfolio, over and above the YTM (yield-to-maturity). So that is the second play, which is the capital appreciation over the course of the next three years.
And the last play is, the currency play. Historically, for the last 20-25 years, the INR has depreciated almost 3% to 3.5% year-on-year against the U.S. currency. If that continues to happen for the next three to five years, you can very well add that additional 3% to 3.5%, over and above the returns, which you will make from the YTM and the capital appreciation.
So put it all together, yes, it looks fairly attractive. Yet, it is a fixed income allocation for very savvy clientele and highly sophisticated clients. But the risks are also threefold—if the rate cycle doesn't reverse, if the yields go up further, if the US dollar doesn't appreciate that much. I think those risks have to be accounted for. So, the risks are equally high on this.
Nisreen Mamaji, do you have any strong views in either direction on this latest offering from the Aditya Birla stable?
Nisreen Mamaji: Typically, investing in any new fund offer will involve understanding your own financial goals, your risk tolerance, and the market conditions.
Having said that, there are two bonds which are available right now—one in the 1-3 year segment and another in a 3-10 year segment. The investor will need to know the tenure that they are investing in, whether it is in the 1-3 year bucket or in the 3-10 year, as well as their risk appetite for either of these.
Now, what we feel right now is that the U.S. Federal (Reserve) interest rates are at multi-decade high. So, there is an expectation of rate cuts in the near future. This could present an opportunity for the investor to lock in at a higher rate and take advantage of the capital gains possibility.
Also, it is a hedge against the INR depreciation. So, if you feel that the rupee is going to go in the direction that where you were hesitating to take that risk, then yes, you can invest in the U.S. Treasury bond.
Also, if you want to park your money internationally, the LRS (Liberalised Remittance Scheme) route has a certain limit. Also, the TCS (tax collected at source) is 20%. However, for this kind of a product, there is neither any capping of amount, nor any TCS applicability. So, for those reasons you can consider this particular investment. As Mohit has already said earlier, it is for a sophisticated investor.
Now, having said that, there are a few cons also. So, the market risk will still be there. You could be subject to interest rate risk, inflation risk, and general market fluctuations. It also exposes the investor to the currency risk, if it goes the other way around and not according to your expectations.
If the interest rates move differently, then you will be seeing a lower return because there is an inverse proportion relationship between the yield and the coupon rates. Also, you know, there is not much track record of this kind of fund. So, we don't really have a precedent for judgment.
I have given you a few pros and a few cons. And I think we should make a very sort-of-a-judgment, which will look at both the pros and the cons and whether you yourself are a sophisticated investor with either of these tenure buckets.
Let us assume that the investor is sophisticated and is open to taking the risk of interest rates. History shows us that the INR has depreciated and it is likely that continues, rates are at highs at some point of time, they will come off. Let us assume the investor has taken all of these into account. Mohit, would you, if you are such an investor put in money to work in this NFO?
Mohit Gang: I think there are just two points to consider out here. In case the investor is wanting to invest internationally, which is wanting to have a U.S. dollar denominated asset, which is extremely safe and as Nisreen has rightly said, doesn't use your LRS pool. So, you send it in rupees, you invest in rupees, and you redeem in rupees. So obviously, your LRS pool is not touched.
So, if you want to develop that kind of a corpus, which is a safe corpus for any of your financial goals—your child's education or something—then, I think this merits an extreme amount of attention.
And secondly, your return expectations have to be fairly tepid with this. So, you can't really expect double digit returns from this kind of a product. Your return expectation has to be between 4% and 8%. If you are really lucky, you might just end up on the higher band of this range, or maybe a little higher, if all three factors—the currency, rate cut and yields—work for you.
The Helios Flexi Cap Fund, the NFO from Helios, is about to start from next Monday. Should people look at flexi cap as a category? If yes, should people look at Helios for the flexi cap or choose some other fund house? Why and why not?
Nisreen Mamaji: Flexi cap is one of my favourite categories, as regulated by SEBI, because all that it requires is to have 65% of a scheme’s total assets in equity. There is no cap like in the multi-cap fund, where a certain amount needs to be invested in large caps, mid caps, or small caps.
In a flexi-cap fund, the fund manager has the ability to choose, irrespective of the market cap. So, there is a large stock of companies which you can choose from with a range of capitalisation, without having a set percentage allocated to any particular cap—large caps, mid caps, or small caps.
Also, it could be interesting to investors, because typically a flexi cap will have a large-cap bias, and tactical allocation will be in the mid or a small-cap category, which is the situation right now with all the other flexi caps available in the market.
Therefore—large, mid-size, small size—any company can be part of a flexi-cap fund, keeping in mind the mandate of the fund and the fund manager's call. And secondly also, because the time horizon that an investor should be looking at for a flexi cap fund is typically between 5-7 years. You must give that much time to the fund to perform to meet your goals. A shorter time frame than that will not be adequate for you to be investing in a flexi-cap category.
Now, Helios has been started by Samir Arora and Dinshaw Irani, who are both ex-Alliance (Capital). They have a philosophy, which is based on eight parameters on which they follow the EI technique, which is the elimination technique.
So, it is not what you add, but what you eliminate from the entire universe, which could be Nifty 500 for example. So, they have eight parameters in which they are eliminating stocks and the reason why they have actually come up with the flexi-cap fund is because the NSE 500 has returned up-to-date this financial (year) about 12% to 13%. Last year, it was only 4.4%.
So, they feel in 20-21 months, it will be a normalised number. And if you convert it, to also rupee terms appreciation, in dollar terms, it is about 10%. So, in dollar terms, the foreign investor has made about five to 6% in 21 months.
So, they also feel as far as the investors are concerned, when you are looking at the rupee terms appreciation, or the dollar terms of appreciation, they feel this is a good offering. Also, because they are probably going to have 50% in large caps and the balance 50% may be in mid and small. So that is the reason that they have also selected the flexi cap as one of their first offerings to our mutual fund industry in India.
Do you recommend that?
Nisreen Mamaji: I would recommend it, but typically, we stay away from investing in a completely new fund house unless we have a track record to show to our investors.
So, I will be very honest and say I will not be recommending Helios fund house's offering of the flexi cap. But flexi cap as a strategy, we have offered to a lot of our investors and we are very happy with the results. Even somebody who has a moderate risk profile has been very happy, because they don't want to be 100% in large cap through the years. We have sort of graduated from 100% large cap, to may be a flexi cap or a large and mid-category and we have obviously seen very superior customer experiences in that.
Mohit, what is your view?
Mohit Gang: I didn't get your question about Helios Capital. The only thing I know is, Samir Arora. And that is what is being spoken about and that is what is perhaps creating some amount of waves if at all it is creating. And honestly, it is all about the person out there, the person at the helm. And finally, as mutual fund advisors also, we typically go and give an extreme amount of weightage to the fund manager, his capabilities, his managerial capabilities, his track record, his past history, so on and so forth.
So, out here, we have an impeccable record from the gentleman out there. He is, in fact the longest serving fund manager—if you take the Indian mutual fund industry—the oldest and the longest. And that, is a very big track record to have, and he goes with Alliance along with Dinshaw Irani.
They were consistently rated the best fund houses for consecutive three or four years, if I am not wrong and even the PMS (portfolio management service) in the AIF (alternative investment fund) track record of Helios which they run currently in India, they have almost Rs 1,800 crore of assets out there. It is again, a fantastic track record. So, on the track record side, I think they have an established pedigree. Globally, they are known names. They operate out of Singapore for the bulk of the offshore clients and even along the funds and hedge funds and so on and so forth.
But my whole thing is look, I think the great part about this entire setup is the research will be common, whether it is the Singapore desk, whether it is the India desk, whether it is the PMS desk or the AIF desk, the research plate is common. They will adopt and change depending on the client profile. Yes of course, they will not be as aggressive as they could be perhaps in a PMS or an AIF, but they will still adopt the same research, the same methodology across, uniformly.
So, I think, given the pedigree of the fund manager, which is Mr. Samir Arora himself, I think, it merits attention. However, as Nisreen rightly said, we are also not the ones who kind of go ahead and advise on NFOs. But this is something we will be keeping a very close eye on. And honestly, if someone is really impressed with Samira Arora’s track record, I don't think so it is that shutter case. One can perhaps look at it with an open mind if they really want to invest. But I think, within six months to a year, if they really show some performance, this will definitely deserve some attention.
