The Securities and Exchange Board of India, or SEBI, has now permitted mutual funds to use interest rate futures (IRF) contracts to hedge risks from volatility in interest rates.
An IRF contract is an agreement to buy or sell the value of an underlying debt instrument (such as a government bond) at a specified future date at a price that is fixed today. Such contracts provide an avenue to hedge against risks arising from fluctuations in interest rates.
In the monthly debt portfolio disclosure, mutual funds will have to disclose the hedging positions through IRF, details of IRFs used for hedging, and investments made in interest rate derivatives.
Morningstar’s director of fund research, Kaustubh Belapurkar, shares his views on the issue:
SEBI’s move to allow mutual funds to use IRFs to hedge interest rate risk is a positive one conceptually.
Earlier mutual funds were allowed to hedge using IRFs only if they held that particular underlying security. So currently, IRFs trade on the 91-day T-Bill, 6-year G-Sec, 10-year Benchmark G-Sec and 13-year G-Sec.
This new mandate allows mutual funds to carry out hedging based on the weight average portfolio modified duration (subject to certain conditions) as funds may choose to take exposure to the non 10-year benchmark G-Sec or G-Secs of other maturities, depending upon the their interest rate view and relative spreads.
A manager who is structurally positive on interest rates, and running a long duration on his portfolio, can now use IRFs to hedge against volatility in interest rates in the short term especially around events that could have a significant impact on the yields in the short term.
For instance, when the RBI policy action is due and the market is uncertain about the stance the central bank will take, yields can be volatile and managers who are long duration can choose to hedge their portfolio using IRFs in case the yields start moving up.
Another such example could be around the announcements made by the Federal Reserve regarding rate action.
That said, the current volumes on IRFs are fairly limited and it will be interesting to observe how volumes pick up after this announcement and how actively fund managers do use these instruments.
