IN the world of fixed-income investing, managing liquidity and minimising risk are vital to successful portfolio management. One popular instrument that can add value to a portfolio and play a crucial role in these areas is the repurchase agreement, commonly known as a “repo”, which essentially functions as a collateralised loan.
As popular as this investment option is, not everyone understands what they are and what are the benefits. So, what happens when you purchase a repo? As an investor you buy an asset from your broker/investment house, and they commit to repurchase the asset from you at a specific date in the future. The price that the broker will repurchase the agreement is predetermined from inception and determines the rate that you earn. As the investor you are actually lending the financial institution cash in exchange for collateral.
Benefits of a Repo
One of the key benefits of a repo for the investor is liquidity — not just in the sense of earning more than a traditional savings account, but also in the ability to access their funds relatively quickly if needed.
Although a repo has a set maturity, investors can typically encash or break the agreement early, subject to certain conditions or interest adjustments. This means that if your financial needs change, you’re not locked in the way you might be with a long-term fixed deposit or other restricted investment. This added flexibility makes repos a practical option for short-term investing, while still offering higher returns and security backed by collateral.
The second benefit of a repo is that they are collateralised. Investors should investigate and ask their advisors what is the underlying asset backing their repo. This is important because if the borrower is unable to repay the investor may call on the asset to recoup their funds. This contrasts with a local savings account with the Jamaica Deposit Insurance Corporation’s (JDIC), which only offers coverage of up to $1,200,000 per depositor, per insured institution, for each ownership category and so you funds aren’t fully protected.
Another benefit of a repo is that upon maturity investors can easily roll or change the tenor of their repo. It offers flexibility to meet specific timelines for an investor. Repos enable investors to deploy surplus liquidity efficiently while maintaining flexibility to reallocate when market opportunities arise. This benefit highlights how agile an investor can be when using repos to shift their investment strategy.
Like any other investment, everything with a repo is not always rosy. Investors should know they are low risk but not risk free. The underlying collateral is very important to be aware of especially if you are truly low risk. Some repos will offer a higher rate because the backing asset may fall outside of your risk tolerance. You should be confident not only in the institution offering your repo but the underlying asset. Speak with your licensed advisor to educate yourself on the rate that you are receiving.
Repurchase agreements offer investors a unique combination of security, yield, and flexibility. Repos may be a key element to enhance and make a cornerstone of your portfolio.
Christine Rankine is assistant vice-president -personal financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in US dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm
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