Rupee down, US yields up: Is it time to add Treasuries to your portfolio?

Mumbai: The surge in US Treasury yields, with the 10-year touching 5.37% earlier this month, its highest since 2002, is opening another avenue for Indian investors to access the world’s largest economy. With the rupee weakening and the gap between US and Indian bond yields narrowing, experts advise considering US debt to diversify fixed-income portfolios.

Global bond yields have been rising amid a surge in crude oil and other commodity prices, driven by the West Asia war. That is stoking inflation concerns and prompting a shift towards tighter monetary policy. The gap between 10-year US and Indian government bond yields has narrowed to around 2 percentage points. The shrinking differential is adding to the appeal of dollar-denominated debt, particularly as the rupee has depreciated 8.38% against the dollar over the 12 months to 23 October.

Nirav Karkera, head of research and fund manager at W by Groww, said interest in US debt is building amid high US yields and a weaker rupee. Indian mutual funds investing in US Treasuries manage only about ₹400 crore, largely because most have stopped accepting fresh investments due to the industry’s overseas investment limits, he said.

A weaker rupee can boost returns in rupee terms. For instance, a 4-5% return in dollars on short-term US Treasuries could translate into 7.5-8% in rupee terms, before fees and taxes, assuming annual rupee depreciation of 2.5-3%.

One alternative is to invest through the Liberalised Remittance Scheme (LRS), which allows Indian residents to remit up to $250,000 a year for permitted transactions. At Vested Finance, a global investment platform that gives Indian retail investors access to international financial markets, around 5% of investors have invested in US debt, said Viram Shah, the company’s founder and chief executive. Here is a closer look at the available routes and the considerations for investors.

Different routes

One option is to invest through an Indian mutual fund scheme that invests in US Treasuries or other overseas debt securities. Investors can transact in rupees without opening an overseas brokerage account, while the fund handles the investments. However, most such schemes have stopped accepting fresh subscriptions because of the industry’s overseas investment limits: $7 billion for overseas mutual fund investments and a separate $1 billion limit for overseas exchange-traded funds (ETFs). Those limits are already exhausted.

“The more practical route today is LRS, which allows individuals to remit up to $250,000 a year for eligible overseas investments, including US Treasury securities and US-listed Treasury ETFs, while accounting for foreign-exchange conversion costs and tax collected at source (TCS),” said Karkera.

Investors can access overseas-listed products, such as the iShares 20+ Year Treasury Bond ETF, iShares 0-3 Month Treasury Bond ETF and Vanguard Total Bond Market ETF, through platforms such as INDmoney and Vested Finance, subject to product availability. While this route offers a wider choice of investments, investors must factor in foreign-exchange conversion costs, brokerage charges and tax-compliance requirements, and be comfortable managing an overseas investment account.

“GIFT City could become a convenient route for US debt as more products offering exposure to US debt are launched,” Karkera said.

Tax considerations

Indian debt funds purchased on or after 1 April 2023 no longer qualify for long-term capital gains treatment and are taxed at the investor’s applicable income-tax slab rate, irrespective of the holding period. Gains on US-domiciled debt ETFs, however, are subject to a different tax treatment, with long-term capital gains taxed at 12.5%.

Shah said the tax treatment of ETFs holding US bonds depends on the product and remains unsettled in some cases. Indian tax authorities and financial experts continue to debate whether these funds should be taxed as foreign assets or as debt funds. “Tax should not be the main reason to move money into US debt,” Shah said.

The rupee is an important determinant of returns, Shah said. A weaker rupee boosts returns in rupee terms, as it has over the past year, while a recovery in the currency can erode them. “US debt is a currency decision as much as a rate decision,” he said, adding that diversification is a stronger reason to consider US debt, given that most Indian investors hold nearly all their fixed-income assets in rupees.

A small dollar allocation could make sense for investors who expect to spend money overseas in the next few years, such as on education or travel, Shah said. He also advised investors to favour shorter-maturity Treasuries. Longer-dated bonds are more vulnerable to price declines if yields rise further, while shorter maturities carry less interest-rate risk.

The US-10 year yield has eased since early October, and was at 4.97% down from an early October peak of 5.37%.

Small allocation

Investors should also account for the 20% tax collected at source (TCS) on qualifying remittances exceeding ₹10 lakh in a financial year. Although the amount can be adjusted against tax liability, it ties up cash, Shah said. He also advised investors to consider US estate-tax exposure on US-domiciled funds. US estate tax can be as high as 40% on US-situated assets exceeding $60,000 for certain non-US investors, while Ireland-domiciled Undertakings for Collective Investment in Transferable Securities (UCITS) funds generally do not carry the same direct US estate-tax exposure for non-US investors.

Karkera recommends treating US debt as a diversifier, allocating around 5-15% of a debt portfolio to it and favouring shorter maturities. Investing in US Treasuries involves both a fixed-income decision and a currency decision. While high yields may be attractive, they also reflect factors such as interest rates, inflation risks, heavy government borrowing and a large supply of Treasury securities.

For most Indian investors, experts advise building exposure gradually and keeping it modest, with a focus on short-duration US Treasuries and the diversification benefits of holding dollar-denominated assets.