Portfolio Optimisations for Corporate Treasuries

At IME Capital, we believe that there is a substantial scope for optimising the post-tax portfolio yields of corporate treasuries. 

Recent changes in Debt MF Regulations & Fund Characteristics that widen category options

The last few years, have seen a number of changes in Debt MF regulations & fund characteristics, driven by SEBI norms & market forces that have lead to a strong case to consider debt MF categories other than liquid for corporate treasuries

  • SEBI MF Classification Norms: The 2017 SEBI MF classification norms, have come out with very clear guidelines on what types of papers different debt MF categories can hold. Liquid funds can no longer hold paper more than 91 days of maturity, making low & short-duration funds a lot more attractive from a yield perspective. 
  • Traditional load & liquidity differences between liquid, low & short-duration funds no longer exist: Traditionally, only liquid funds (and certain specific funds labelled liquid-plus) enjoyed T+1 liquidity and no exit loads. However, over-time this benefit of superior liquidity (T+1) and no exit loads are also now common across most ultra-ST, low and short-duration funds. 
  • Change in Debt MF Taxation: from 1-Apr-2023, Debt MF’s no longer enjoy the benefit of favourable long-term capital gains tax, and any gains on redemptions of Debt Mutual Funds will now be added to the investors income and taxed based on their tax-slab. This makes the taxation rate similar to Bank Fixed Deposits, even as they still enjoy the benefit of only being taxed on redemption as compared to Bank Fixed Deposits which are taxed every year. 

Using Investment Horizons to identify the best Debt MF category to invest in

In order to understand why different Debt MF categories are relevant for different investment horizons, it is important to understand a few dynamics of what determines debt MF returns:

  • Yield Curve: Typically longer-duration paper offers higher yields. Investing in longer-duration debt funds, allows you to earn a higher yield-to-maturity on your debt MF holdings. 
  • Changes in market interest rates: Bond prices rise when interest rates fall (and fall when interest rates rise), with longer-duration bonds being more sensitive to interest rate changes. 
  • Returns to investors: are broadly driven by the YTM +/- the mark-to-market changes due to interest rate movements. 
10-Year India G-sec Yields (2012-22)

Short-duration funds have a higher YTM than liquid-funds. However, due to a higher duration, short-duration funds can have larger mark-to-market losses in rising interest rate environments.

Accordingly the right fund category to hold, depends on your view of interest rates over the investment period. 

Falling Interest Rates

Rising Interest Rates

This benefit of changing the category of funds based on the view on interest rates can be seen based on a study we have undertaken on the relatively performance of Short-Duration funds vs Liquid Funds for the top 3-AMCs. 

The same study of the relative performance of short-duration to liquid funds, clearly shows that for longer-holding periods, short-duration funds are clearly superior to liquid funds. 

Note: Category-wise returns (above table) are based on the average point-to-point returns of the funds from the respective category of top-15 AMC.

Avoiding over-diversification to lower-risk

Potential for inclusion of non-traditional fund categories

Depending on the specific investment mandate of the corporate treasury (driven by it’s risk-profile, funding needs & shareholding structures), certain non-traditional investment opportunities may be considered that can help substantially boost portfolio yields. This can include

  • Longer-duration debt funds: during periods where interest rates appear to have peaked
  • REITs/InVits: gaining exposure to yielding Grade A commercial real-estate or infrastructure projects
  • Conservative Hybrid Funds: some marginal exposure to equities (15-20% of fund) to boost yields, while limiting downsides in weak markets
  • Market-Linked Debentures: due to their tax-efficiency (even while credit risk of the borrower needs to be carefully considered)
  • Absolute Return (Market-neutral Long-Short strategies): focusing on long-short strategies that aim to make consistent monthly positive returns, with low-volatility
  • High-Yield AIFs: may be considered, based on an assessment of the credit risk being taken (vs incremental yields)
  • Equity: which may be considered for longer-duration investments in closely-held corporates