SEBI has allowed debt fund managers to execute imperfect hedging through interest rates futures (IRFs). This will help fund managers reduce interest rates risk in debt portfolios.
Under imperfect hedging, fund managers do not necessarily hold a debt security in the portfolio to buy interest rate futures of that particular security. For example, fund managers can buy interest rates futures of a 10 year G Sec even without having exposure to 10 year G Sec in the underlying portfolio.
So far, fund managers could only hold interest rate futures of a security if they had the security in their underlying portfolio.
Fund managers can now hold such imperfect hedged IRFs to up to 20% of net assets of the scheme.
However, the fund managers will have to maintain 90% correlation between the underlying securities and the interest rates futures. In a circular, SEBI said, “Mutual Funds are permitted to resort to imperfect hedging, without it being considered under the gross exposure limits, if and only if, the correlation between the portfolio or part of the portfolio (excluding the hedged portions, if any) and the IRF is at least 0.9 at the time of initiation of hedge. In case of any subsequent deviation from the correlation criteria, the same may be rebalanced within 5 working days and if not rebalanced within the timeline, the derivative positions created for hedging shall be considered under the gross exposure computed in terms of Para 3 of SEBI circular dated August 18, 2010. The correlation should be calculated for a period of last 90 days.”
Dwijendra Srivastava, CIO – Debt, Sundaram MF believes that the move will increase liquidity and reduce interest rates risk in the portfolio. “The move will help fund managers reduce interest rates risk by taking a call on interest rates movements. If a fund manager believes that interest rates will go down, he may take a long duration call by putting a small premium. If the call goes right, the gain is unlimited; however, if it goes wrong, the portfolio will loss only a nominal amount.”
