Know how to diversify your portfolio with US bonds

US treasuries are an increasingly compelling alternative to risk assets given that interest rates are expected to keep rising for some more time. The S&P 500 earnings yield, essentially the inverse of the price-to-earnings ratio (P/E), serves as a valuable metric for investors. It offers insight into the return on investment in terms of company earnings for every dollar invested in the market. Currently, the two yields are converging at approximately 5%, marking the narrowest gap seen since at least 2005.

Nifty’s earnings yield stands at 4.5%, whereas a 1-year US treasury note offers 5.43%, as of 9 October. This convergence signifies an intriguing development where bonds are now providing a substantial challenge to stocks as an investment choice. Investors are confronted with a new reality: the presence of numerous alternatives, often referred to as ‘TAMA’ (there are many alternatives), thanks to the allure of high-risk-free interest rates.

Sovereign guarantee

With the US Federal Reserve on a rate-hike spree, 1-year US treasury yields have climbed up from 0.38% in 2022 to 5.59% in October, making it a good time to invest in US debt. Given the inversion in the US yield curve (long-term yields are lower than short-term yields, see chart), the 0-1-year segment offers the highest yields of 5.43% to 5.59%. Compared to this, 10-year US treasuries are offering 4.80%. And once you account for returns in rupee terms assuming the Indian currency depreciates, that adds another 4-5% to your dollar-denominated returns. Over the long run, the rupee has depreciated against the dollar, though there have been phases when the Indian currency has appreciated. If we look at 1-year rolling returns, in 10 of the 11 years since 2012, the rupee depreciation has added to the US dollar-denominated returns.

Also, while US treasuries trade at lower yields than the government of India debt paper, with the gap between the two narrowing, having exposure to US debt has become relatively more attractive today. This yield gap has narrowed from around 400 basis points (bps) to 164bps since January 2022. The US sovereign debt, a very high-quality asset, enjoys AA+ rating compared to India’s BBB- rating from rating agency Standard & Poor’s.

Bandhan US Treasury Bond 0-1 year Fund of Fund (FoF)

The FOF invests in JPMorgan BetaBuilders US Treasury Bond 0-1 year UCITS ETF, an exchange traded fund with exposure to 0-1-year US treasuries. The FOF will have 100% exposure to US treasury except for some cash holdings for liquidity needs.

The fund invests in US Treasuries maturing in up to one year’s time, which makes it low-risk from an interest rate risk perspective. It is designed with limited sensitivity to bond durations, making it ideal for those seeking a USD asset for financing short-term or predefined expenses without exposing themselves to equity market-related volatility. The fund has a modified duration of only 0.30. This implies that for every 1% change (rise) in interest rates, the fund NAV, or net asset value, will be impacted (fall) by only 0.30% .

The fund’s primary objective is to provide Indian investors with a straightforward means to hedge their exposure to the US dollar.

“Bandhan US Treasury Bond 0-1 year Fund of Fund seeks to provide investors the opportunity to create a USD asset for funding a near-term or potential expense. The funds invest in high-quality US government securities with a short maturity period, offering an ideal combination of high-quality and low-volatility investment opportunities”, said Sirshendu Basu, head– products, Bandhan AMC.

US bond ETFs

You can also invest in international ETFs tracking US Treasuries through domestic brokers with international partners or international brokers with domestic presence. Although you can access a decent universe of bond ETFs on these platforms, US treasuries and US agency bonds are of major interest. The only major caveat are the costs associated with it. Brokerages can charge fees ranging from 0.2-1% per trade up to an upper limit in dollar terms. Then you face the burden of withdrawal charges every time you seek a withdrawal after selling. Currency transfer costs and impact costs(bid-ask spread) also add to the costs.

This investment will fall under the Reserve Bank of India’s Liberalized Remittance Scheme (LRS) which permits Indians to freely remit up to $250,000 per financial year for any permissible foreign currency transaction. Following the budget 2023 proposal, all such transactions will attract 20% tax collected at source, or TCS, (up from the earlier 5%) from 1 October. That means, you will have to set aside an extra 20%, which will be withheld by the tax authorities, for the same investment as before. Also, such foreign investments have to be disclosed in your income tax returns even if you fall under the tax-exempt category, adding to your compliance burden.

Bond baskets

A few Indian fintechs are looking to introduce global custom created bond baskets which offer diversification in terms of geographies and maturities diversification. These will also include primary issuances of international bonds. The products are still in the beta stage. An executive of one of the fintechs told Mint that their initial basket size would be around $25,000 and this would come down with due demand and time.

Word of caution

While investing in fixed income is generally perceived as a safe option, exposing one’s portfolio to international markets increases the compliance burden. Also using new brokers can bring in platform and execution risks as well. Do your due diligence carefully.