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FSM in Media: How to make the most of liquid funds?
December 14, 2015

Liquid funds pose an opportunity to individuals, looking to park their funds for short time periods. However, do not select the fund that tops the charts.

Author : Dr. Renu Pothen

 How to make the most of liquid funds?

This article was published on on December 7, 2015.

A majority of us start our financial journey by first opening a savings bank account and we take it for granted with most of our surplus being accumulated in this account. The sad part is that, although the rate of return on this account is only 4% per annum, we do not bother to make an effort in seeking other options that can give us better returns. We park our surplus in this account to quickly meet any short term requirements. I believe that the mutual fund industry has an answer to this in terms of liquid funds which is still considered to be the preferred investment option of institutional investors. It is only very recently that our retail investors have started taking an interest in this category, but I think that the fund houses and advisers will have to put in a great deal of efforts to get the investors acquainted with the virtues of investing into liquid funds. My endeavor in this column is to make investors aware about the importance of using liquid funds as an opportunity for parking surplus to meet their very short term requirements, thereby offering a good substitute for the savings bank account.

When we categorize funds in the mutual fund industry on the basis of risk, liquid funds are at the bottom of the pyramid. From the SLR (safety, liquidity and returns) point of view, this category is considered to be the safest and liquid in the industry. The term safest is used in a relative sense vis-à-vis other categories of fixed income funds and does not mean that there is barely any risk associated with these funds. Liquid funds can invest in debt and money market securities of a very short nature and the average maturity of these funds is generally less than 60 days. These instruments, having a short maturity are not subject to interest rate volatility as compared to other debt categories having a longer maturity period. However, this does not entirely mean that they will be completely immune to interest rate risks. I would like to quote the example when liquid funds went negative in July 2013, on account of RBI’s decision to increase the short term rates to stem the volatility in our currency. This is only an instance that shows liquid funds are also subject to volatility, if the central bank suddenly decides to reverse their stand. However, investors need to note that this is only a rare instance and is not the norm.

There is a perception among investors that liquid funds can be used to park surplus funds to meet their contingency requirements. However, I would like to differ with this view and my point is that as these funds have the redemption rule of T+1, it is not an ideal parking ground to meet ones needs on a rainy day. This is because, whenever we have an emergency requirement, we would need funds immediately and would not want to wait for a day to get our surplus. However, if investors have very fixed short term goals like paying for children’s tuition fees every quarter, meeting down payment requirements in the next two months and so on, then these goals can be met by using the liquid funds option. Here, investors are sure about the dates on which these goals need to be met; hence they can put in the redemption request 1 or 2 days prior to meeting this goal.

In the last few years, we have been observing a trend wherein liquid funds are being used by investors as a parking ground for their surplus which needs to be moved into equity funds whenever there is a correction in the market. This is a good trend, but if the investors are fine with volatility and have a time frame of 6 months to gradually move the surplus into equity funds, then they can opt for ultra short term funds.

A careful analysis of the liquid funds portfolios in the industry shows that a majority of the concentration is in instruments with a rating of A1+. A few of the funds have also taken an exposure in the AAA corporate debt space. However, my concern is with funds that have instruments rated below AA, the existence of such papers in liquid fund portfolios is not justifiable to investors. Fund Houses need to remember that retail investors who were satisfied with the 4% return earned in a savings bank account are moving their surplus into liquid funds which will not just give them a better return but also satisfy safety parameters. Hence taking low quality papers in liquid funds and causing panic among investors if there is a default, will not be acceptable as in a normal savings bank account, investors hardly lose sleep over this investment opportunity.

To conclude, I would recommend investors not to close their eyes and select any liquid fund that tops the chart but to carefully analyze the portfolio and then take a final call. When I say portfolio, my reference is to the quality of instruments held. Any fund taking low quality papers, however good the returns, should be avoided. Investors need to remember that they are moving their surplus from a savings bank account on which they hardly stress to another instrument which ideally should be able to give them peace of mind and in turn let them fulfill their short term goals. 

Disclaimer: iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's scheme information document including statement of additional information. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer on the website.Please read our disclaimer in the website.

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