What is TREPS in Mutual Funds & Why Mutual Funds Invest in TREPS?

Mutual funds follow a diverse investment strategy to grow wealth while maintaining flexibility. TREPS (Treasury Bills Repurchase Agreement) is a low-risk option for short-term investors. It allows mutual funds to earn returns on idle cash while ensuring liquidity. Investing in TREPS helps funds manage money efficiently, reduce risks, and enhance overall performance. This analysis explores TREPS, why mutual funds invest in it, its impact on fund performance, and the benefits it provides to investors seeking stability and flexibility.

Table of Contents

What is TREPS?

TREPS (Treasury Bills Repurchase) is a short-term borrowing arrangement in which securities are temporarily sold with a promise to repurchase them at a predetermined price on a specified date. It involves borrowing and lending funds against collateralised government securities. The transaction is facilitated by a third party, which ensures security and compliance. For Mutual Funds, TREPS (Treasury Bills Repurchase) provides a mechanism to park surplus cash while maintaining liquidity and earning returns efficiently.

Fund managers use TREPS to manage the short-term liquidity requirements of Mutual Funds. The fund manager invests in TREPS to ensure the ready availability of cash to redeem or to take advantage of any investment opportunity. Such transactions are backed by government securities, carry a low risk, and are suitable for Mutual Funds.

How Does TREPS Work?

TREPS involves government-backed securities, which are considered safe and secure investments. It also provides quick liquidity, making it an ideal choice for mutual funds that need access to cash on short notice.

A bank or financial institution sells treasury bills to another party (such as a mutual fund) for a short period.
The mutual fund purchases these treasury bills and holds them temporarily.
The original seller (bank or financial institution) buys back the treasury bills at an agreed-upon price, allowing the mutual fund to earn a small profit.

Why Do Mutual Funds Invest in TREPS?

The rationale behind Mutual Funds investing in TREPS is multifaceted. Here are some key reasons:

Liquidity Management

Liquidity is a vital element in Mutual Fund operations. Mutual Funds require maintaining adequate cash or liquid assets to meet daily redemptions from investors. TREPS offer a safe route for handling liquidity without sacrificing returns. The short tenure of TREPS, which is from overnight to a few days, ensures that funds remain available whenever needed.

Safety and Security

Since TREPS transactions are backed with government securities as collateral, they are inherently secure. This low-risk profile aligns well with the conservative investment mandates of many Mutual Funds, especially liquid and debt funds. The involvement of a tri-party ensures transparency and mitigates counterparty risks.

Short Term Returns

Idle cash in a Mutual Fund portfolio can be insufficient for overall returns. Through TREPS, Mutual Funds can invest idle cash and earn some short-term income on that surplus cash, thereby maximising portfolio performance without significant risks.

Regulatory Compliance

Regulatory bodies such as the Securities and Exchange Board of India (SEBI) require Mutual Funds to maintain a certain percentage of their assets in liquid instruments. TREPS helps Mutual Funds meet these requirements while simultaneously providing a safe and efficient investment option.

Portfolio Diversification

TREPS is used to diversify a portfolio that belongs to a Mutual Fund. It allows the manager to reduce the overall portfolio’s volatility and exposure to fluctuations in the market.

Short-Term Liquidity Requirements

TREPS helps Mutual Funds when there is an immediate liquidity requirement to seize investment opportunities or an urgent requirement to raise money.

Benefits of Investing in TREPS

High Liquidity

TREPS are essentially overnight instruments, making them highly liquid.
Funds can be quickly deployed or withdrawn, ideal for short-term cash management.

Low Credit Risk

Transactions are secured by collateral (typically government securities).
CCIL acts as the central counterparty, minimizing counterparty default risk.

Better Returns than Traditional Savings Instruments

Returns are typically higher than those from savings bank accounts or fixed deposits of similar tenor.
Suitable for conservative investors seeking low-risk alternatives with slightly better yields.

Regulatory Oversight

Regulated by the RBI and managed by CCIL, ensuring high transparency and compliance.
Reduces systemic risk compared to unregulated lending or borrowing.

Safe for Mutual Funds and Institutional Investors

Widely used by mutual funds, insurance companies, and other financial institutions for overnight parking of funds.
Helps maintain liquidity and meet redemption pressures.

Efficient Cash Management

Corporates and institutions can earn returns on idle cash instead of keeping it unproductive.
Useful for treasury operations in large organizations.

Risks of Investing in TREPS

Interest Rate Risk

Although minimal for overnight instruments, changes in interest rates can affect returns if rolled over continuously.
Lower repo rates during a dovish monetary policy stance can lead to reduced returns.

Reinvestment Risk

Since TREPS are short-term (usually overnight), there’s a constant need to reinvest the funds.
Reinvestment may be at lower yields, especially in falling interest rate environments.

Liquidity Risk (in abnormal conditions)

While highly liquid under normal circumstances, in periods of extreme market stress or systemic disruptions, liquidity could temporarily dry up.
Could affect large institutional investors more than retail participants.

What is TREPS?

TREPS (Treasury Bills Repurchase Agreement) is a short-term borrowing and lending instrument that banks, financial institutions, and mutual funds use. In simple terms, it is a transaction in which one party sells government securities (such as treasury bills) to another party with a promise to buy them back later at a predetermined price.

How Does TREPS Work?

A bank or financial institution sells treasury bills to another party (such as a mutual fund) for a short period.
The mutual fund purchases these treasury bills and holds them temporarily.
The original seller (bank or financial institution) buys back the treasury bills at an agreed-upon price, allowing the mutual fund to earn a small profit.

Why do Mutual Funds Invest in TREPS?

Investments in TREPS by mutual funds exist to fulfill the goals of the safety of assets along with liquidity requirements, improved yields, and regulatory compliance. The following subsections analyse each purpose in detail:

Safety of Investment

The financial market identifies TREPS as its most secure investment possibility. When federal government securities underpin a transaction, it eliminates almost all possibilities of pledge default. TREPS is an investment choice for mutual funds since they use it to protect their portfolios against market variations.

Quick Liquidity – Easy Access to Cash

Mutual funds require quick access to funds to cover shareholder withdrawal requests and fund rebalancing requirements. The quick conversion feature of TREPS investments allows mutual funds to obtain cash whenever they need it without complications.

Higher Returns Compared to Savings Accounts

Mutual fund investors invest their assets through TREPS to obtain superior returns than bank account interest. Because TREPS features interest rates that exceed those of ordinary savings accounts, they have become a preferred choice for short-term investment needs.

Regulatory Compliance (SEBI Guidelines)

The Securities and Exchange Board of India (SEBI) requires mutual funds to place 5% of their assets into investments, which include Treasury Bills and Real Estate Purchase Receivable Securities. Due to this, mutual funds maintain liquidity while ensuring financial stability. The requirement of SEBI ensures that mutual funds operate with enough liquid assets to maintain both financial transparency and stability.

Portfolio Diversification & Risk Management

Mutual funds achieve risk reduction by using TREPS to expand their investment portfolio. Mutual funds benefit from TREPS investments as portfolio protection against market volatility because they absorb some wild swings in stock market performance. The steady income from TREPS investments can help offset losses from a declining stock market.

How TREPS Affects Mutual Fund Returns

TREPS investments impact mutual funds differently, including their Net Asset Value (NAV), risk level, and overall returns. Let’s understand these effects in detail.

Positive Impact on NAV (Net Asset Value)
When mutual funds invest in TREPS, they earn small but steady returns.
These returns increase the mutual fund’s Net Asset Value (NAV), raising the share price.
A higher NAV makes the mutual fund more attractive to investors.
Stabilising the Portfolio
TREPS investments act as a safety caution against market fluctuations.
During stock market downturns, the portion of the mutual fund invested in TREPS remains stable and unaffected.
This helps in reducing overall volatility in the mutual fund’s performance.
Impact on Fund Returns
While TREPS is a low-risk investment, the returns are also lower than stocks or corporate bonds.
If a mutual fund invests too much in TREPS, its overall return potential may be reduced.
However, a balanced approach between TREPS and higher-risk investments ensures safety and growth.

Benefits of Investing in TREPS

TREPS provides multiple benefits to both mutual funds and individual investors. Below are the key advantages:

Safety & Security

TREPS involves government-backed securities, making it one of the safest investment options.

High Liquidity – Easy to Buy & Sell

Since TREPS is a short-term instrument, mutual funds can easily convert it into cash.

Better Returns than Bank Deposits

TREPS provides higher interest rates than savings accounts, ensuring better returns on idle cash.

Regulatory Compliance (SEBI Requirement)

Mutual funds must invest at least 5% of their assets in liquid investments like TREPS, ensuring financial stability.

Portfolio Diversification & Stability

By investing in TREPS, mutual funds can reduce overall risk and stabilise returns, making them a safer choice for conservative investors.

Risks of Investing in TREPS

While TREPS is generally safe, there are some potential risks:

Lower Returns Compared to Other Investments
TREPS offers lower returns than stocks, corporate bonds, or mutual funds investing in equities.
A mutual fund investing too much in TREPS may lead to lower growth potential.
Interest Rate Fluctuations
Market interest rates influence returns on TREPS.
If interest rates drop, TREPS returns may also decrease.
Limited Investment Period
TREPS is a short-term investment, meaning it must be frequently reinvested.
This creates a need for constant monitoring and management.

Conclusion

TREPS is a crucial investment tool for mutual funds, allowing them to manage idle cash, maintain liquidity, and ensure the safety of funds. Since government securities back TREPS investments, they provide low-risk and stable returns.

Understanding TREPS investments is important for mutual fund investors as they play a role in determining the fund’s stability, liquidity, and returns. A well-balanced mutual fund that wisely invests in TREPS and other assets can offer both safety and profitability to investors.

Next time you invest in a mutual fund, check how much of its assets are parked in TREPS to understand its liquidity and risk management strategy.