Invest in US Treasury debt fund for currency hedge: What is on offer?

There could be losses if interest rates rise or rupee appreciates

The yield on the 10-year United States (US) government bond touched 5 per cent recently, a 16-year high. Meanwhile, Aditya Birla Sun Life Asset Management Company (AMC) has announced two new fund offers (NFOs) of schemes that will invest in units of Exchange Traded Funds (ETFs) that invest in US Treasuries. In March 2023, Bandhan Mutual Fund (MF) had launched its Bandhan US Treasury Bond 0-1 Year Fund-of-Fund.

What is on offer?

Aditya Birla Sun Life US Treasury 1-3-Year Bond ETFs Fund of Funds and Aditya Birla Sun Life US Treasury 3-10 Year Bond ETFs Fund of Funds invest in units of ETFs that invest in US Treasuries that mature in one to three years and in US Treasuries that mature in three to 10 years, respectively. Bandhan MF’s scheme invests in units of an ETF that invests in US treasuries maturing in less than one year.

These are passively managed products with low expense ratios. “The FoFs are a simple and cost-effective way for Indian investors to create assets denominated in US dollars and invest in US Treasuries which are one of the safest assets globally,” says Kaustubh Gupta, co-head fixed income, Aditya Birla Sun Life AMC.

Exposure to dollar assets

These funds provide exposure to the US dollar. An investor who has a dollar-denominated goal such as child’s education abroad or a foreign vacation may look at these funds to manage the currency risk. Investment in government bonds also takes care of credit risk.

“There are three possible advantages of investing in US Treasuries—low credit risk, currency gains if the rupee depreciates against the US dollar, and possible mark-to-market gains if interest rates head down or healthy accruals in case yields remain where they are currently,” says Vishal Dhawan, founder and chief executive officer (CEO), Plan Ahead Wealth Advisors.

These schemes also help in avoiding the tax impact on forex transactions.

“Investment in US treasuries through an FoF will not lead to utilising the Liberalised Remittance Scheme (LRS) limit of $250,000. So, it will not attract any Tax Collected at Source (TCS),” says Sirshendu Basu, head–products, Bandhan AMC.

Basu adds that US dollar assets can be matched with any future liability or expense in US dollars, providing a hedge against USD-INR currency movement.

Currency hedge

US Treasuries are the classic counter-cyclical and safe-haven asset. “They have historically appreciated in times of risk-off. Hence, they are an excellent investment avenue for Indian investors, given the rupee’s historical tendency to weaken in such scenarios,” says Gupta.

An investment in these FoFs could lead to capital gains in the financial year 2024-25.

“With the US Fed perhaps reaching the peak of its rate hike cycle and rate cuts expected by the second or third quarter of the next fiscal year, an investor could earn mark-to-market gains in addition to yields if and when interest rates decline,” says Dhawan.

Interest and currency risk

Investors need to be cognisant of the risks in these funds. “If the rupee appreciates, it would affect fund return. An interest rate hike would also impact returns. But since these funds have a low duration, the impact would be low,” says Basu.

The three funds in this category lack a track record currently.

Invest for medium term

Investors should be prepared to hold these investments for the medium term to see meaningful returns.

“The ideal holding period should be one to three years. The investment in an international bond fund should be a complementary solution to your India fixed-income portfolio. Allocate 5-15 per cent of your fixed-income allocation to this strategy, depending on the breakup of the outlay on your domestic and international financial goals,” says Dhawan.

Investors should, however, have moderate return expectations from these funds.

For their longer-term dollar-denominated goals, the bulk of their international investment should be in overseas equities through index funds or actively managed equity schemes with a sound track record, which can help compound wealth.

Those who do not have dollar-denominated financial goals may stick to domestic fixed-income instruments.