What is TREPS & Why Mutual Funds Invest in it?
Financial markets today offer a wide variety of financial products to investors. There is a lot of information about financial products, and you may see something new daily. If you’ve ever looked through a mutual fund’s portfolio, you’ve probably noticed that some of your money is invested in “TREPS.” Are you certain about what it is and why practically every mutual fund has a portion allocated to it?
In this blog, we will explore TREPS, its features, advantages, disadvantages, and the reasons behind mutual funds investing in TREPS.
What is TREPS?
TREPS stands for “Tri-Party Repo Dealing System”, which facilitates the borrowing and lending of funds in a Tri-Party Repo arrangement. Tri-party repo is a type of repo contract where a third entity (other than the borrower and lender) acts as an intermediary between the two parties to facilitate services like collateral selection, payment, settlement, custody, and management during the life of the transaction. It serves as a mechanism for managing liquidity, allowing mutual funds to park their excess capital.
Why Mutual Fund Invest in TREPS?
Mutual funds invest in TREPS for various reasons listed below:
- Liquidity: It provides mutual fund flexibility to manage the liquidity for daily needs, as it easily converts securities into cash to meet daily redemptions. Quick conversion into cash also allows mutual funds to take advantage of investment opportunities.
- Safety: TREPS are backed by the government and are considered highly safe.
- Earnings: It allows the mutual funds to earn a return on the idle cash and helps increase the overall return.
- Regulatory Requirement: According to regulations, mutual funds must invest a small portion of their assets in liquid securities such as TREPS.
- Portfolio Diversification: Investment in TREPS provides diversification benefits and reduces exposure to market fluctuations.
Impact of TREPS on Mutual Fund NAV
The impact of investing in TREPS on the mutual fund’s NAV depends on various factors, such as current market conditions, current portfolio mix, and the size and duration of investments in TREPS.
Investing in TREPS offers higher returns than cash, which increases net asset value (NAV).
On the other hand, a sizable investment in TREPS can result in lower returns in the long run, and thus, NAV reduces.
Key Players in Mutual Fund TREPS transaction
The key players involved in mutual fund TREPS transactions are as follows-
- Sellers: These entities initiate the transaction by selling the securities and agreeing to buy them back later.
- Buyers: The buyer is a counterparty that purchases securities and earns interest.
- Tri-Party Agent: These agents provide services such as collateral selection, payment, settlement, custody, and transaction management. They are critical in reducing counterparty risk.
- Custodian: The custodian stores the securities, ensures their safety, and makes them available at the time of settlement. Its role is usually combined with that of a tri-party agent.
- Clearing Corporation: CCIL (Clearing Corporation of India Limited) serves as a clearing house, ensuring that all the executed trades are settled properly and maintaining accounts for all members.
- Regulatory Bodies: The regulatory bodies such as SEBI (Securities and Exchange Board of India) set guidelines to protect the investor’s interest.
Advantages of TREPS
TREPS offers the following advantages to its investors:
- A mutual fund holds some cash to meet redemption requests. Instead of holding cash, they invest in TREPS as they are highly liquid.
- It also allows mutual funds to earn additional income, increasing the overall yield of the portfolio.
- Through TREPS, mutual funds can reduce the volatility of a portfolio.
- It allows them to manage their cash flows efficiently and act actively on market opportunities.
- TREPS is considered a risk-free investment option as the government backs it.
Disadvantages of TREPS
Disadvantages of TREPS are:
- Investment in TREPS offers lower returns when compared with other opportunities available in the market.
- The involvement of a third party increases the complexity of the transaction, which also increases its cost.
- Most mutual funds have investments in TREPS, eventually leading to the concentration of risk.
- TREPS are subject to market risk due to changes in interest rates, which can affect the return of mutual funds.
Conclusion
In conclusion, investing in TREPS offers mutual funds a safe, flexible approach to managing capital and boosting portfolio return while preserving adequate liquidity. They also have a positive impact on the mutual fund NAV in the short term, but a longer investment horizon can result in lower returns and negatively impact the NAV.
TREPS are affected by interest rate changes and often offer lower returns than other asset classes. Speak with your investment advisor if you intend to invest in mutual funds.
Frequently Asked Questions (FAQs)
Who do mutual funds put their money in TREPS?
Mutual funds must place their assets in liquid securities like TREPS to comply with SEBI regulations requiring them to have a certain amount of cash on hand to fulfill investor redemption requests.
What does TREPS stand for?
TREPS stands for Tri-Party Repo Dealing System.
Who can participate in TREPS?
Any institutional investor, including banks, mutual funds, etc., is eligible to invest in TREPS if they meet the regulatory compliance guidelines provided by SEBI and have the required infrastructure.
Is it safe to invest in TREPS?
Yes, it is safe to invest in TREPS as the government backs the underlying assets.
Does TREPS generate higher returns than traditional savings accounts?
TREPS investments have the potential to yield larger returns than traditional savings accounts, which is why mutual funds find them attractive.
