The avenues to invest overseas are increasing. From the usual equity offerings – ETFs or fund of funds – tracking US benchmarks or other global indices, we now have a debt scheme that seeks to invest in the supposedly safest debt avenues globally. IDFC US Treasury Bond 0 to 1 Year Fund of Fund seeks to gain from the current high yields in short-term US treasuries. The new fund offer (NFO) will be open from March 10 to March 23.
The runaway near double-digit inflation from late 2021 and much of 2022 in many advanced economies and even emerging markets meant that Central Banks around the world embarked on an interest rate hiking spree. Rate hikes were sharp in most cases, with the US increasing rates by 450 basis points in just the last year. As a result, short and long-term treasury yields have risen sharply - the former, more than the latter. Does that present an attractive investment opportunity?
Here’s what you must know before investing in the IDFC US Treasury Fund.
Yields, interest rates and curve inversions
Interest rates and yields generally move in tandem. Since 2021, US 10-year treasury bond yields rose steadily and are currently at 3.3 per cent. Curiously, the one-year treasury yield is at 5.06 per cent from 0.72 per cent in February 2022. When long-term yields are lower than short-term figures, we have yield inversion. So, investors have bought more long-term securities, while selling short-term ones, causing bond prices to fall and yields to rise. Yields and bond prices move in opposite directions. This yield inversion also indicates investors fear of an economic slowdown or recession.
For perspective, India’s 364-day treasury bills trade at 7.39 per cent. The spread (difference in yields) between US and Indian treasury bills was 390 basis points in February 2022, but is down to 233 basis points currently.
Given the current high yields, there is an opportunity to lock in. If yields drop from these levels, there would be a bond price rally and gains for investors in the form of capital appreciation. That’s part of the pitch for the IDFC US Treasury Fund: if we assume rates are at or near their peak.
Inflation has cooled from 9.1 per cent in the middle of last year in the US to about 6.3 per cent in January 2023. But the job market continues to be healthy in the US, with unemployment at multi-decade lows of 3.4 per cent, which is seen as a possible trigger for higher wages and overall inflation. Therefore, the Federal Reserve may tighten rates more going by the expectations of some hawkish economists. But overall, many experts are expecting the terminal (or maximum rate hike) to stop at 5.5 per cent levels.
If that happens, yields may not move very significantly from these levels for the foreseeable future, making current investments attractive.
Given that these are US treasuries, there is no credit risk. Also, as the investment universe is bonds in the 0-1 year range, there is little duration risk as well, given that much of the interest rate rise shock may already have been absorbed.
Rupee depreciation against the dollar is the other kicker to returns in general from overseas investments. The movement in the two currencies in the last 20 years is interesting. From 2003 to 2007, the rupee appreciated against the dollar, before falling in 2008. It did stage a comeback against the dollar between 2009 and 2011. But from 2011, barring short periods of gains, the rupee (from 44-45 levels) has generally been on a depreciation path against the dollar.
Currency movements in the future hinge on economic growth, inflation, interest rates, geopolitical factors, and the US dollar’s position as the mainstay in global trade – many countries are settling trade in local currencies. But if a secular depreciation (non-linear) of 3-4 per cent annually, that may add to returns for Indian investors.
What should investors do?
Data from IDFC’s presentation states that the rupee returns on a three-year rolling basis from January 2004 to January 2023 from the US 0-1 year treasury is 4.72 per cent. For perspective, over the same 19-year period, if we take the CRISIL 1-year T-Bill index, the three-year rolling returns are 6.04 per cent. And many older liquid funds have comfortably given 7 per cent type of returns on a rolling basis over this timeframe.
Investing in the US does provide diversification. But that may be better done via equities. However, given the safety of the underlying bonds, the current high yield, and the kicker via rupee depreciation, a small lump sum may be considered by investors as an opportunistic play for diversification outside their core domestic debt portfolio. Investments can be made for a short-term horizon of about three years.
Some financial planners advise US investing to hedge against the dollar and for goals such as children’s education in the US. But that would mean parking a larger sum for relatively modest returns and may not be prudent in this case, as US equities over the long term would be a better bet.