In the world of mutual funds, there are various investment options available. One of the lesser-known, yet significant, investment tools is the TREPS (Tri-party Repo) market. But what exactly is TREPS, and how does it relate to mutual funds? Let’s explore.
What is TREPS?
TREPS stands for Tri-Party Repurchase Agreement. It’s a type of agreement where one party sells securities to another with an agreement to repurchase them at a later date. It is usually overnight or within a few days.
The “Tri-Party” part refers to three participants in the process:
- The borrower (usually a financial institution),
- The lender (often a mutual fund or other investor),
- A clearing corporation that manages the transaction and ensures the proper settlement of securities.
TREPS provides a short-term way for financial institutions to raise funds. In turn, it offers a safe investment option for mutual funds looking to park their cash temporarily.
Role of TREPS in Mutual Funds:
Mutual funds, especially those focused on debt or liquid funds, invest in instruments that offer safety, liquidity, and a steady return. One such investment vehicle is TREPS. Mutual funds use TREPS to invest in the short-term money market, where they can park their funds for a short period (ranging from a day to a few weeks) while earning a return.
TREPS offer lower risk compared to other investments, making them an attractive choice for mutual funds aiming to preserve capital and generate modest returns. The returns on TREPS are generally lower than those on longer-term investments, but they come with the advantage of high liquidity and low volatility.
Example: TREPS Investment in a Debt Fund
Consider a liquid debt fund that aims to provide returns with minimal risk. Let’s say this fund has ₹100 crores in assets under management (AUM). The fund manager might decide to invest ₹20 crores in TREPS for a short period, say one week. The rate of return on TREPS could be around 3% annually.
By the end of the week, the fund earns a small interest (calculated based on the annual rate) while keeping its capital safe. This interest is then passed on to the investors in the form of returns. Since TREPS are backed by high-quality collateral, the risk remains low.
Risks of TREPS:
TREPS are considered low-risk, they are not entirely risk-free. Some of the risks include:
- Counterparty Risk: This is the risk that the borrower (usually a bank or financial institution) may default on the repo agreement and fail to repurchase the securities. Although collateral is involved, in extreme cases, the collateral may not cover the full amount of the loan.
- Liquidity Risk: If the repo agreement is long-term or the market becomes illiquid, there could be difficulty in quickly selling the securities, potentially affecting returns or the ability to access cash when needed.
- Collateral Risk: If the value of the collateral (government bonds or securities) declines significantly, the lender might not be able to recover the full amount of the loan if the borrower defaults.
Conclusion:
TREPS is an important tool for mutual funds, offering a way to manage liquidity while earning a low-risk return. The returns may not be very high compared to other investments, the safety and liquidity they offer make them an ideal option for short-term fund management. But like any financial instrument, there are some risks involved. Understanding TREPS can help investors gain more clarity about how mutual funds handle their portfolios efficiently.
– Ketaki Dandekar (Team Arthology)
Read more about TREPS in Mutual Funds here – https://groww.in/treps