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IRFs can be an interesting option

But getting too aggressive with the instrument can hurt if you get the view on the direction of interest rates wrong. Have limited exposure

Priya Nair  |  Mumbai 

If you have a view on interest rates, that is, if you feel these are either headed up or down, you have the option of participating in the fixed income market by investing less than Rs 10,000. Thanks to the new interest rate futures (IRFs) launched by MCX-SX on Monday, and the National Stock Exchange on Tuesday, it is possible for retail investors to benefit from their view on these.

IRFs are similar to equity futures. Here the future contracts of 'buy' or 'sell' are of underlying government bonds, similar to future contracts of stocks. The minimum contract value is pegged at Rs 2 lakh and initial margin which you have to pay upfront is around three per cent. This works out to Rs 6,000. If you have a view that interest rates on G-Secs are likely to come down, say from current levels of 8.5 on 10-year G-Sec to eight per cent, the options to invest and make returns are an income fund, tax-free bonds, non-convertible debentures (NCDs) or G-Secs directly. But because of liquidity issues and smaller ticket sizes it is not easy to get in and come out easily with the exception of mutual funds. If you want to get out of your mutual fund investment before one year, you will have to pay exit loads. Similarly, in the case of tax-free bonds or G-Secs, it is very difficult to find sellers, especially if the amount of bonds you want to sell is small.

This is where IRFs will provide an additional option and an easy entry and exit. You can make a profit (bond prices rise when interest rates fall), if your views turn out to be right.

“There is going to be high liquidity IRF market this time because of product re-tuning. It is another option to invest if you have a directional view on interest rates. But there is also the risk of losing your capital, due to which retail investors usually stay away from derivatives,” says Prateek Pant, director, products and services, RBS. According to Feroze Azeez, director and head investment products, Anand Rathi, “If you feel your call is wrong you can let the contract expire. But usually it is better to roll over the contract for six months to one year, because by then usually the interest rates scenario will change and you can recover your capital,” he says. Azeez says he would advise it for individual investors, since most of them have portfolios skewed towards debt. However, one should do it only after a thorough understanding of the product. One way to gain from a view on interest rates is to divide your investment between a fixed maturity plan (FMP), which will offer a fixed return, and IRF, since you can get out of it by booking profits. How much should be divided between the FMP and the IRF will depend on the view on interest rates. “You can use the FMP as a passive portfolio and the IRF as an active portfolio. Since it is only futures and not options, you can only sell it or rollover. So, the risk is minimised,” Azeez says.

While theoretically IRFs can be used to hedge your long-term loans such as home loans or your investment in long-term instruments like tax-free bonds, experts advise against it. "Retail investors invest in tax-free bonds for the consistent tax-free income that it provides over the long term. So, there is no need to hedge your in tax-free bonds,'' Azeez says.

First Published: Tue, January 21 2014. 22:29 IST